Setting The Expiration Date Based On Economic Releases
When it comes to trading binary options successfully, a trader must not only be a good predictor of the direction of the price movement of an asset but also understand when such a price movement would occur. Hence, the trader must not only select the right kind of option (put or call) but also the appropriate expiration period.
In one of our previous articles, “Measuring the Time Element to Set The Expiration Date of an Option”, we covered in detail how to measure and set the expiration period of an options based on certain chart patterns; namely triangles and pennants.
In this article, we will explore in brief how understanding the timing of the various economic releases, can be used as another factor in setting the appropriate expiration date in conjunction with charts and other technical analysis tools.
The NFP Example
NFP stands for “Non-Farm Payroll” and is an official monthly report (generated on the first Friday of the month) by the US Bureau of Labor Statistics. It is an employment report of non-farm employees which represent the total number of paid employees minus farm employees, general government jobs, private household jobs, and non-profit organizations. The most major metric tracked by the NFP report is the number of jobs added since the previous month; turn on the news during this time and you’re sure to find the talking heads discussing the NFP numbers. You can find the official NFP reports here.
The NFP report is extremely significant and is a major market mover because it is used as a good gauge of the overall health of the US economy. If the data in the NFP report is not what the market was expecting, then you can be assured of a high degree of volatility and market movements as the market corrects itself. Market movements prior to the release of the report are usually characterized by strong consolidation areas (meaning that the market is indecisive and the price moves within a range).
Knowing this, how should we set the expiration date of an option?
Well, what we want to do in this case is to set the expiration date of an option either at the end of the week if the trader spots a pattern forming, or if a trader spots a pattern over an even longer timeframe, then the expiration date should be set at the end of the month. The idea behind this is to avoid the volatility that surrounds the release of the report and to avoid being fooled by ‘false breakouts’ which are price movements that seem to show that the price is breaking out of a pattern, always a great trading opportunity, but in this case is just the price still trading within a range; it only looks like a breakout because of the high volatility.
Using the Economic Calendar
So while the above example was for a specific economic report, in this case the NFP, which is a very US-centric report, traders must also know what are the relevant economic releases that affect the price movement of the underlying assets on which they are buying binary options. A great example is trading currency pairs; when it comes to this kind of trades, traders should pay close attention to the official releases from the central banks of the respective countries; in particular interest rate decisions.
For the US, everybody watches the FOMC meeting, which is the meeting where the Federal Reserve makes a decision on key interest rates. For instance, the interest rate was recently raised in December 2016, and as a result the dollar has been on a strengthening path since (see their meeting schedule here). In Europe, market players keenly watch the monetary policy meeting of the European Central Bank, which sets the key interest rates for all of Europe (see their schedule here).
Again, when it comes to setting the expiration date of an option, we want to follow the exact same strategy as in the NFP example. Prior to such important releases, strong consolidation areas within large ranges are common, and the high volatility may be mistaken for false price breakouts and lure traders into the wrong move. Hence, it is advisable to set the expiration date far enough from the meetings in order to be able to take advantage of real price breakouts, should you be able to recognize them from prior patterns.
What about Stock Trading?
And finally, we come to the example of stock trading. While the aforementioned major economic releases can affect the stock market as a whole, if we are buying binary options with individual stocks as the underlying then we must understand what are the company-specific releases that will affect the price movements.
In the United States, the SEC requires that earnings reports be filed later than 45 days after the end of the first 3 quarters and up to 90 days for the end of the fiscal year. For certain publicly-listed companies, this time period is shortened to 35 days and 60 days, respectively. Dividend announcements, which also have a major effect on price movements (given that many investors buy certain stocks solely for receiving dividend payments) are also typically announced on this date. Traders can easily find the upcoming dates for a specific company on their website or on the SEC website.
And just like the examples above, these releases can trigger high volatility so the same rules with regards to the expiration date apply.
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References and Further Reading:
- Stock Repurchase by Tender Offer: An Analysis of the Causes of Common Stock Price Changes (RONALD W. MASULIS)
- Common stock repurchases: An analysis of returns to bondholders and stockholders (Larry Y. Dann.)
- Option pricing: A simplified approach (John C. CoxStephen A. RossMark Rubinstein)
- The behavior of the volatility implicit in the prices of stock index options (Theodore E Day)
- Hedging Performance and Basis Risk in Stock Index Futures (STEPHEN FIGLEWSKI)