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Hamish Raw

Hamish Raw

Hamish Raw has an MBA from Cass, London where he specialised in financial engineering, in particular, the pricing and risk management of conventional options.Raw has…

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WTI - $95 again? But when? - The Binary Option Call Timeline

The attached chart illustrates the slow but determined rally of WTI from its early November lows with the price once again threatening the $95 level. The question might be ‘when’, as opposed to, ‘will’ it touch $95. The binary option strategy, the Call Timeline, might provide the appropriate instrument for such a view.

WTI Price Chart
WTI Price Chart. (Click on picture to enlarge.)

Call Timeline

The call timeline in conventional options jargon a calendar call strip, except in the case of the call timeline, the call options constituting the strategy are ‘one-touch’ calls as opposed to the European ‘vanilla’ binary call. The call timeline consists of four one-touch calls with the same strike price and expiry dates occurring at four separate times in the future. The aggregate price of the strip is then divided by the number of expiry dates (4) to provide the price of the call timeline.

If the price trades at (or higher) than the strike by the first expiry the call timeline immediately settles at the maximum possible value of 100. Should the strike price not be achieved in this first time period but is achieved in the second time period, then the call timeline immediately settles at $75. And so on with the settlement values of the third and fourth time periods being $50 and $25. Should the asset price not touch the strike price by the last expiry time then the call timeline settles at zero, it has expired worthless.

Related Article: Why are Banks Allowed to Manipulate the Oil Markets?

WTI Call Timeline

Below is an illustration of the price profile of the $95 Call Timeline that has first expiry in five days then expiry dates every seven days. When WTI is trading at $90 with 26 days to expiry this call timeline is valued at 17.13 which is lower than the 25 settlement price available should the WTI price scrape home in the last expiry period. Yet should the price of WTI reach $95 within the initial five days then then the strategy provides a return of 484%.

WTI $95 Call Timeline – 1 Week Expiry Increments
WTI $95 Call Timeline – 1 Week Expiry Increments

During the oil bull run of 2006 prior to oil never having traded at higher than $100 before, there was great speculation as to when this momentous event would take place. The below illustration has replicated this scenario with a $100 strike call timeline with the expiry dates being the last Friday of each month with the final month being April. Here the price of the 103-day timeline is 16.49, yet again providing a good return irrespective of when the WTI price hits $100, although within the first time period it provides an exceptional return of over 500%.

Related Article: Looking for Coal and Natural Gas Stocks in Fluctuating Markets

WTI $100 Call Timeline – 1 Month Expiry Increments
WTI $100 Call Timeline – 1 Month Expiry Increments

This binary option is therefore a valuable strategy for those speculators who too often get the direction correct but their timing wrong.

For those writers of premium this strategy provides a couple of additional advantages. Firstly the option caps out, like all binary options, at a value of 100 thereby eliminating the undesirable element of unlimited downside risk associated with the writing of conventional options. Secondly, the incremental premium can be collected as each expiry period passes thereby providing a revenue stream which the writing of other strategies cannot provide.

Summary

The Call and Put Timelines alleviate the immutable old adage that ‘Timing is Everything’ with an instrument that rewards those traders that get both the direction and timing right, but also provide a lesser return for those traders that have got the direction accurate but are not so clever at forecasting when.

By. Hamish Raw - See more on Google


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