Volatility is probably the biggest difference between binary options and their vanilla counterparts. Binary options are slightly less volatile due to their fixed payout, so you don’t have to lose nerves because the trend fell short of your predictions. Although, volatility can be a good thing, too: it could potentially make your profits skyrocket if things really go your way, but it is statistically far more likely to cause you major financial damage. Other than that, binary and vanilla options share all their major components: call and put versions, underlying market, expiration date, pricing components etc. Having said that, this article is about volatility trading through binary options.
Now, when it comes to volatility, it is important to distinguish implied volatility from historical volatility. Historical volatility explores the price movement in the past, while implied volatility deals with the expectations concerning price movement in the nearby future. This is in direct correlation with the pricing of a binary option: if the chances for the outcome are estimated at 50%, the price will also be around half of the total payout of 100 dollars per option. The less likely the outcome, the lower the price, which in turn means more potential profit.
Binary options are considered especially useful if no major shifts are expected in the market in the nearby future. If there are no major shifts in trends, vanilla options actually offer less payout than binary options.
Volatility buying implies acquiring out of the money (OTM) binary options; their outcomes are considered less likely, so their initial price is quite low but potential payouts are high – when they eventually happen. Out of the money options are call options whose strike price is higher than the market price or put option with strike price below the market value. They are losing from the start, and if they expire as such, they are worthless – unless market changes and they yield a ton of money. In the money (ITM) options are their opposite. By acquiring out of the money options at low price, you aim at huge payouts when their outcomes eventually come true. Combining cheap binary options with even cheaper helps you decrease the risk, but this means little in the end.
Volatility selling implies acquiring in the money binary options; their outcomes are considered very likely, so their initial price is quite steep and payouts are low – but they usually deliver. One way to ensure profits is to buy the same binary options, but with different strike ranges: one strike higher than the other (the profit on those will be higher as well), but their direction is the same. That way, if you got the trend right, you get more money than by focusing on the safer bet alone. And if you are only half-right, the safe bet will still save you from major losses. This strategy helps you exploit the trading range of a stock or commodity.