Schaeffer's Outside the Box Blog
Stocks quoted in this article:

In my never-ending quest to wonder why its okay to wager on anything financial-sounding, but verboten to bet on anything football-sounding, I bring you … Nadex.com.

I'm not exactly sure who they are, but they advertise on Bloomberg all the time, so they at least have attained "Sham-Wow" status. As I type, they're also the top ad on the right at the excellent Beyond The Bets site, which is -- incidentally -- a sports betting site.

Anyway, Nadex bills themselves as an actual Market-Maker-to-Market-Maker exchange, with no commissions, only exchange fees. And also, no regular options; they list binary options and bull call spreads.

A binary option is effectively identical to a yes-or-no prop bet like "Will Eli Manning throw more than 30 TD passes this year" -- except it's on something financial-market related. Here's one of their examples:

Screenshot of Nadex.com

The advantage of a binary option is the defined risk aspect. If you buy USD/JPY straight up at 78.06 and it goes to 76.06, or whatever, you get slammed. Here, you only lose the amount of your bet.

Why not just buy regular calls, you say? Well, you obviously have that max loss aspect, but you'd also have to pay some sort of premium. The binary bet gives you a maximum win even if USD/JPY closes only a penny above the strike, whereas on the straight call, you need to also make that premium back.

The binary price is the probability of the event -- more or less the delta of a regular option at that strike. For example, if there's a 44% chance of the SPDR S&P 500 Index (ETF) (NYSEARCA:SPY) closing above "X" three hours from now, the binary will cost you $44 per contract. And incidentally, Nadex only has very short-term contracts; they list options with between 2 hours and 22 hours, 15 minutes until they expire.

So, if these are the type of bets you want to make, sure, binaries sound great. But they're purely bets. I'm not sure what portfolio hedging strategy involves wagering on whether the SPYs are over or under some price by 2pm today. Nor am I sure where there's any edge here over time.

They do sound fun and pretty non-evil though. And they're way easier for the casual investor to understand than a levered ETN that tracks an ETN that tracks constant duration VIX futures. And hey, like a sporting event, the pain or gain happens quickly and you can move right on to the next trade. Here's a YouTube video that gives a full description of their products.

Disclaimer: The views represented on this blog are those of the individual authors only, and do not necessarily represent the views of Schaeffer's Investment Research.


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