Risk Latte - Binary Call on Hang Seng Index

Binary Call on Hang Seng Index

Team Latte
Dec, 2004

If an investor is extremely bullish on the Hang Seng index (Hong Kong equities) and wants to bet on a rise in the market, then he can think of a binary option. In this case he has a target in mind and wants to gamble on that target.

Buy an ATM (at the money) binary call option on Hang Seng Index at the current level. The index closed on 9th December 2003 at 12,393. The investor buys a bet that if in six months time the index will close at this price or higher then the seller will give him US$1 million or else he gets nothing.

If we assume the historical volatility of the Hang Seng index to be 17.74% today then the cost of the six month binary ATM call option on Hang Seng index will be approximately US$474,995.

In other words an investor will pay the seller (bank or his brokerage house or some other counter-party) an amount equal to US$474, 995 to buy a bet on Hang Seng Index, such that after the expiry of six months from today if the index closes at or above the level of 12,293 (today’s level) then he will get US$1 million, and if the index is below that level he gets nothing.

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