Posted by forex at 1:20 AM
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1. Trade digital ( also called binary) options for a single payout. Digital options have a simple logic: if a security settles at or above a certain price you receive a previously agreed upon fixed payout. The decision is binary- it is true or not true.
2. Trade American style options for dollar-for-dollar gains once the strike price is achieved even before the expiration date. The American option is conditional - you must cross the strike price and you are recompensed by degree of correctness. Digital options are traded in over the counter markets and European markets. They may not be exercised prior to the call date.A stock is trading on expiration day at 22. A digital option written 3 months earlier when the stock was at 10 has a 1 point payout and trades at 1. With a strike at 20 an American style option is worth 2.
3. Know that digital options are part of a class of options called exotic options. Exotic options imitate different real world decision making problems. Examples of exotic options include look-back options, chooser options and Bermuda options. Digital options are used in stock, bond and mortgage backed securities.
4. Trade a synthetic digital option (an option created by a combination of various puts, calls, strike prices and maturities) made of American options. An example would be a bull spread trade already in the money. For example a stock trades at twenty. An investor buys the 15 call and sells the 20 call. The investor's upside is known at the outset of the trade. Downside is the cost of the options.
5. Understand that the only difference between American style and digital options is the probability calculation or likelihood that a stock will go substantially above its strike price. This means that each style can be created synthetically from the other option style.