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HedgeStreet, circa Russell Andersson:

Binary Options
Binaries Description

Binaries have the following characteristics:

* A Binary is a $100 contract between a buyer and a seller (both HedgeStreet members) – the buyer taking the position that a certain strike price will be reached or a certain event will happen on the expiration date, and the seller taking the position that it will not.
* Buyers and sellers trade contracts at prices based on their sense of the perceived likelihood that a price will or will not rise, or an event will or will not happen. Thus, the value of each Binary is equivalent to the probability of the corresponding situation, as the potential gain is always a fixed amount of $100 per contract.
* Since the value of each Binary is equal to the perceived probability of the event occurring, all contracts can be immediately compared. For example, if an event appears to have an 80% chance of happening, the buyer pays $80 per contract, and the seller pays the balance of the $100 contract, or $20.
* If the price of the underlying exceeds the strike price or the event does happen on the expiration date, the buyer receives $100, and the seller gets $0, thereby losing their initial investment.
* If the price of the underlying does not exceed the strike price or the event does not happen on the expiration date, the seller receives $100, and the buyer gets $0, thereby losing their initial investment.

Cash requirement:
The cash requirement is the maximum that can be lost if the predicted outcome does not occur. For the buyer, it is the contract price. For the seller, it is $100 minus the contract price.

Final payout:
At expiration, the payout is always $100 per Binary. The buyer receives $100 if the price of the underlying exceeds the strike price or the event does happen and $0 otherwise. The seller receives $100 if the price of the underlying is equal to or below the strike price or event does not happen and $0 otherwise.

Additionally, traders can close out their positions prior to expiration by selling (in the case of an initial buyer) or buying (in case of an initial seller) their Binaries at any time before the last trading date. In such cases, the profit and loss is the difference between the price received and the price paid.

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HedgeStreet, circa Russell Andersson:

Futures Contract Description
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Futures Contracts have the following characteristics:

1. A Futures Contract is a $0 – $100 Futures contract between traders where one takes the position a market will rise (the Buyer), and the other takes the position the market will fall (the Seller).
2. Traders determine Contract prices based on their sense of the likelihood of the outcome.
3. If the market rises, Buyers profit and Sellers lose, according to the amount of the rise.
4. If the market falls, Sellers profit and Buyers lose, according to the amount of the fall.
5. The cap and floor of the Contract’s range limit the potential loss to the amount invested, and limit the potential gain to $0-$100 (the contract size).

Cash requirement:
The cash requirement is the maximum that can be lost if the underlying ends at or below the Floor (for Buyers) or at or above the Cap (for Sellers). For a buyer, it is the contract price. For a seller, it is the contract size (which is up to $100) minus the contract price.

Final payout:
At expiration, the payout is based on the ending level of the underlying, relative to the Contract’s range.

If the underlying ends at or below the floor, the payout is $0 for the buyer and the stated contract size (of up to $100) for the seller. If the underlying ends at or above the cap, the payout is the stated contract size (of up to $100) for the buyer and $0 for the seller.

If the underlying ends between the floor and the cap, the stated contract size is split between the buyer and seller, where the buyer receives $Y for every X tick the underlying finished above the Floor and the seller receives $Y for every X tick the underlying finished below the Cap, such that payout for the buyer increases when the underlying ends closer to the cap, and payout for the seller increases when the underlying ends closer to the floor.

Example: For Crude Oil $70.00 to $80.00, with a $100 contract size – if Crude Oil ended at $77, the buyer would receive $10 for every $1 Crude Oil finished above $70, or $70, while the seller would receive $10 for every $1 Crude Oil finished below $80, or $30.

Additionally, traders can close out their positions prior to expiration by selling their Futures Contracts at any time before the last trading date. In such cases, the profit and loss is the difference between the price received and the price paid.

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I took those excerpts on the old HedgeSteet website. It may not reflect their current website. Visit them to get updated, if you need.

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See also TradeFair‘s binaries.

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My preferred vocabulary for InTrade and BetFair’s services:

• event derivative markets
• prediction markets

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What is best execution?
What does the changing background indicate on the trading platform?
What is my net position for a market?
How is my average price calculated?
What is Trading?
What is Close Out?
What is Realised P&L?

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What is best execution?
Best execution is the process by which Tradefair Binaries will match a user’s bet at the same price or better price than asked for, when available. This normally occurs in two ways

1. the best price may be only offered at a small stake while the second best price at a much larger stake. A user may enter the required price as the second best, which has the effect of matching the small bet at the better price and the large bet at the second best price. This process has the added advantage of somewhat protecting users from entering totally erroneous prices;
2. where a user has entered a bet but, before it is confirmed, better odds become available. A user will always get the best price available at the time of matching.

What does the changing background indicate on the trading platform?
The Tradefair Binaries betting interface has been designed to show how the prices are moving on the exchange.

Every time the best buy or sell price for a market changes, the background to the price flashes according the direction of the price change – blue for an up price move, red for a down price move.

What is my net position for a market?
Your net position is:
(Sum of the stakes of your matched buy bets) – (Sum of the stakes of your matched sell bets)

If this is a positive number you have a net long position and you are betting that the event will happen or the binary market will go up in the meantime in order that you can take a profit by closing out your position (see What is Close Out?).

If this is a negative number you have a net short position and you are betting that the event will not happen or the binary market will go down in the meantime in order that you can take a profit by closing out your position (see What is Close Out?).

Example of a net long position:
If your matched bets are:
Buy bet of £2 per point @ 30
Buy bet of £1 per point @ 40 Sum of stakes of matched buy bets = £3
Sell bet of £1 per point @ 50 Sum of stakes of matched sell bets = £1

Sum: £3 – £1 = £2

Therefore you have a net long position of £2 per point at 33.3 as shown below.

Example of a net short position:
If your matched bets are:
Buy bet of £1 per point @ 50
Sell bet of £2 per point @ 30 Sum of stakes of matched buy bets = £1
Sell bet of £1 per point @ 40 Sum of stakes of matched sell bets = £3

Sum: £1 – £3 = -£2

Therefore you have a net short position of -£2 per point at 33.3 as shown below.

How is my average price calculated?
The average price is calculated for your matched bets and unmatched buy or sell bets (if applicable).

There are two methods of calculating your average price depending for your matched bets depending on whether you have a Realised P&L.

Method 1 – Applies to unmatched bets and to matched bets if you do not have Realised P&L:

Your average price is calculated as:
( sum of your [bet price x bet stake] ) / (sum of your [bet stake]).

(i.e it is the average price of your bets, weighted by bet stake)

Example of Average Price (1)

In the example above the calculation is as follows:

Bet Price	Stake	Bet Price x Stake
50	2	100
60	1	60
Sum	3	160

Average Price = 160 /3 = 53.33

Important: your average price is shown to 1 decimal place on the interface.

Method 2 – Applies to matched bets ONLY if you have Realised P&L:

Your average price is now adjusted to take account of the change in your net position due to a close out(s).

Your average price is calculated as:
(sum of your [bet price x bet stake] + Realised P&L) / (your net holding).

Example of Average Price (2)

Bet Price	Stake	Bet Price x Stake
50	2	100
60	1	60
70	-1	-70
60	2	120
Sum	4	210
Realised P&L		16.67

What is Trading?
When you trade you are trying to make a profit as prices move up and down. This may involve placing a series of bets which will result in a profit (or a loss) whatever the final outcome.

Often financial traders do not keep a position open until a market expires, but are looking to profit from very short term price movements by closing out open positions with an equal and opposite trade.

The Tradefair Binaries interface has a number of features to make trading easier:

• your profit and loss based on different outcomes (see Where do I see my Profit & Loss (P&L)?)
• the total stake and average price (see How is my average price calculated?) of your matched bets (see Where can I see my matched bets?)
• the total stake and average price of your unmatched buy bets and sell bets (see Where can I see my unmatched bets?)
• your realised P&L amount for the market (see What is Realised P&L?)
• the functionality to Close Out your position (see What is Close Out?)

In the example above you place a series of buy and sell bets at different levels causing your Net Holding to change and each time there is a closing trade the Realised P&L changes accordingly. The final outcome is a flat position with a Realised P&L of £100.

What is Close Out?
If you have a net long or short position in a market you can decide whether to “close out” or offset the position by placing a bet of equal size in the opposite direction – this is what we refer to as Close Out. If the bet matches your position will be zero and the profit or loss reflected in your Realised P&L.

The Close Out function will only be available if there is sufficient liquidity in the market. This is indicated by the or the Close Out amount being clickable. If there is insufficient liquidity the will not be clickable and there will be no Close Out amount shown.

If you select Close Out the deal ticket is automatically populated with an equal and opposite bet to your existing net position.

The price shown in the deal ticket is the price, based on the best three exchange prices, where there is sufficient cumulative liquidity to match an offsetting bet to your position.

If you submit this bet to the exchange and your bet is matched, this will “close” your position in that market, locking in a profit or loss. The bet may be partially matched resulting in a partial close out.

In the example above you have two matched buy bets, of £1 per point @ 20 and £0.60 per point at 25, and therefore you have a long position of £1.60 per point at an average price of 21.9.

The Close Out amount is shown as £17.80 which would be the profit if you closed your position at a binary price of 33.

You decide to Close Out you position and a sell ticket is generated with a stake of £1.60 and a binary price of 33.

The price of 33 is derived from the fact that there is £0.8 per point available to sell at 34 and £0.8 per point available to sell at 33 and a position of £1.60 per point is covered by the cumulative liquidity down to a price of 33.

If there had been insufficient liquidity as shown in the example below then the Close Out function would not have been available.

Please be aware if you submit the Close Out trade, it might not get matched since prices are dynamically changing on the exchange.

The price shown on the Close Out deal ticket may be conservative as part of your order may get filled at a higher price, however if you wish to increase the likelihood of your trade being matched you can amend the price on the deal ticket before submitting this to the exchange i.e decreasing the price if you are selling or increasing the price if you are buying.

(It is possible the Close Out level shown in the example above would be 33.5 – since £0.8 per point is available to sell at 34 and £0.8 per point is available to sell at 33 – resulting in an improved Close Out value.)

Of course if the Tradefair binary price improves whilst you are in the process of placing your bet, you will be matched at the best price available (see What is best execution?)

What is Realised P&L?
Realised P&L for a market is the guaranteed⁽¹⁾ “profit” or “loss” from bets which have been closed out (see What is Close Out?).

The Realised P&L is based on the following calculation:

[(Average price of your net holding before Close Out) - (Price of Close Out bet)] x (Close Out bet stake)

This will be a positive number if your buy price is less than your sell price and vice-versa.

In the example above you have bought £2 @ 30 and £1 @ 40 to give a net position of £3 @33.3.

You then place a down bet of £1 @ 50 which results in a Realised P&L of (50 – 33.3) x 1 = £16.67

(Note: Your average price is only shown to 1 decimal place on the interface but all calculations are done to 2 decimal places or more.)

The Realised P&L will change as you make further Close Out bets as can be seen in the example below.

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⁽¹⁾ other than when the market is voided

TradeFair – TradeFair Binaries

NEXT: Why does Tradefair care about Prediction Markets – by TradeFair’s David Jack – 2007-12-06

Hint: A binary bet represents the probability or percentage likelihood of an event happening. In the example above the price is 66 to sell and 67 to buy. You should buy if you think there is a greater than 67% likelihood of the event happening OR sell if you think the probability is less than 66% likelihood of the event NOT happening.

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Thank you, Eric Zitzewitz and Justin Wolfers (among others).

Interpreting Prediction Market Prices as Probabilities – (PDF – Abstract) – by Justin Wolfers and Eric Zitzewitz – 2005-02-01

While most empirical analysis of prediction markets treats prices of binary options as predictions of the probability of future events, Manski (2004) has recently argued that there is little existing theory supporting this practice. We provide relevant analytic foundations, describing sufficient conditions under which prediction markets prices correspond with mean beliefs. Beyond these specific sufficient conditions, we show that for a broad class of models prediction market prices are usually close to the mean beliefs of traders. The key parameters driving trading behavior in prediction markets are the degree of risk aversion and the distribution on beliefs, and we provide some novel data on the distribution of beliefs in a couple of interesting contexts. We find that prediction markets prices typically provide useful (albeit sometimes biased) estimates of average beliefs about the probability an event occurs.

Previously: BetFair’s Global Warming Prediction Markets — CFM’s Views – Out of their 3 event derivatives on global warming, the first two, at least, are flawed products.

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David Jack (Managing Director of TradeFair, a BetFair spin-off)

Previously: Binaries and Spreads: BetFair spins off TradeFair.

NEXT: Why does Tradefair care about Prediction Markets – by TradeFair’s David Jack – 2007-12-06

–> David Jack (Managing Director of TradeFair) — (Thanks to Niall for the LinkedIn link.)