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How to trade volatility

TRADING PRODUCTS: If you've a prediction about whether a market is likely to be rampant or docile, here's how to make tax-free profits from it
September 1, 2009

Where do you think the pound will be against the dollar by the end of today? Perhaps you reckon it'll land between $1.61 and $1.62. Or maybe you think it could have a turbulent session and therefore end up anywhere between $1.60 and $1.63. If you have a view on the likely range of a market like this, there's an ideal fixed-odds trade you can do to make money from it.

A "double-strike binary bet" is the speciality bet of CityOdds, a small player in the fast-growing fixed-odds financial trading industry. You simply have to choose two levels - one higher and one lower - that you think a certain market is going to end up within by the end of the day.

What you're betting on with a double-strike binary is volatility. If you reckon that a price is going to move around a lot, you specify levels that are much further away from the current price and much closer to the current price if you think little action is in store.

For example, the pound is trading at $1.635. You have a suspicion that by the end of the trading day at 5pm it'll be pretty much around this price. So, you specify barriers at $1.645 and $1.63. Because you think there's a bit more risk of it going higher than lower, you give yourself more leeway on the upside. You enter these terms and CityOdds' site says you'd get 12 per cent return on whatever stake you put down if the price is between your two barriers come 5pm.

As with all fixed-odds bets, therefore, you are told right from the outset what your maximum gain would be if you are correct, and you also know that the most you can lose is your stake. However, you don't have to hang on until the end of the bet. If things either go your way or against you, you can exit your position for a reduced profit or salvage some of your stake. And even though these trades work very much like options, you don't pay tax on your profits because they are classified as bets rather than investments.

So, how does CityOdds compare to other fixed-odds and binary betting sites that we have come across? As a fairly small player, its product range so far is narrower than other providers,' with available markets limited to two currencies, two equity indices, two commodities and, interestingly, UK house prices. Also, bets are only currently offered over one-day timeframes.

Still, what CityOdds does, it does pretty well. The platform is easy on the eye and simple to use. Pricing appears to be competitive, enabling customers to trade in and out of positions profitably - rather than having to wait for expiry - which is not always the case with other companies in the field. A free dummy account facility lets you get to grips with the principles and practice of the whole thing.

Chief executive Mike Chadney says that he is planning to add a wider range of markets and timeframes before too long, and perhaps in time bet types other than just double-strike binaries. One thing we'd like to see is a charting facility on the site. After all, charts are what many traders use to decide their entry and exit levels, as well as to predict volatility, the key element for this type of bet. For instance, a narrowing of the Bollinger bands frequently foretells a breakout in volatility - see the chart below:

We will keep an eye on this site's progress and can certainly recommend a visit to take advantage of the demo account facility.