I like to think of binary events as black and white outcomes that can either make you money or lose you money based on how your prediction pans out. Common examples of binary events are predicting the winners of political elections or major referendums or choosing a sports time to win a game. These are the most common and basic examples, but there are many more that occur in real life and in markets that you may not have considered – and in effect, you may be leaving money off the table. Aside from the common political and sporting examples, some very common stock market situations where you could stand to gain (or lose) in an instant are as follows:
- Arbitrage and Mergers – If you caught the recent major news in pharma, whereby Pfizer was set to buy Allergan, there was a huge break in the deal due to new rules from the US Treasury Department seeking to stop US companies from gaining more favorable tax treatment by buying/merging with overseas entities in tax-advantaged countries. In this case, Pfizer was going to realize significant tax advantages by “inverting” and switching its headquarters to Ireland due to Allergan’s current setup. Given that Pfizer is a huge multinational with a large annual tax bill, the Treasury finally stepped in and enacted rules that would make the deal much less favorable. As a result, Pfizer walked aware from the deal and Allergan’s stock dropped about 20% in a single day. Had you been engaged in a binary trade on Allergan, like put options, you could have made a lot of money in a single day on that news.
- Biotech New Drug Approvals and Clinical Trial Results – This example is even more black and white. Often times, a small biotech with a single drug candidate is seeing huge volatility in its stock because of an upcoming ruling from FDA on whether a new drug will be approved, or in some cases, investors are awaiting clinical trial data which has a previously projected reveal date. Everyone watching the situation knows the stock is going to rocket either up or down on the news, but they don’t know which way (unless you’re an insider). This is yet another binary trade example.
- Earnings Announcements in Tech – My final example is what we used to see play out in Google, Apple and other internet stock earnings announcements, where there’d often be a move of greater than 10% in either direction tied to an earnings announcement. These days, the market seems to have smoothed out some of these announcements as the players have grown larger and surprises are less frequent. But it’s only a matter of time before the next generation of small tech or biotech companies comes up and starts to see similar action. Making investments just prior to scheduled earnings calls is another way to engage in binary trades.
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