Binary Options Basics


Binary Options are a type of option where the payoff is all or nothing. Because of this property Binary Options are easier to understand and trade than traditional options.

 

Binary Options are cash-settled as European-style options which means they can only be exercised on the expiration date. If at expiration the options settle in-the-money the buyer or seller of the options will receive a pre-specified dollar amount. Similarly if the options settle out-of-the-money the buyer or seller of the options will receive nothing. This will provide a known upside (gain) or downside (loss) risk assessment. Unlike traditional options Binary Options are providing full payout due to a single pip movement.

 

Despite the term "all or nothing" depending on the trading platform "nothing" can actually mean "something". This implies that at expiration time the owner of the option may actually get a certain payout amount even if the option expired "out of the money"

 

Very often you may come across Binary Options under another name. In the Forex market Binary Options are known under the name of digital options.

 

Learning Steps

 

1) Learn the two outcome options: A trader of Binary Options needs to foresee the expected direction of the price movement of the underlying asset. Within the most platforms the two choices are called as Put and Call. Put is the prediction of a price decline while Call is the prediction of a price increase. Unlike traditional options knowing the dimension of the movement is not required. Instead you should only be able to predict whether the price of the chosen asset will be higher or lower than the starting price.

 

2) Decide your position: Your should assess the current market conditions surrounding your chosen asset and determine if the price is more likely to rise or fall. If your insight is correct,on the expiration date your payoff will be the settlement value of your contract. The profit rate on each winning trade is decided upon by the broker and this amount is always made known upfront.

 

3) Learn how the price is determined: The price of a Binary Options contract is equivalent to the probability of the event happening. For example if the contract worth has a value of $100 and the last trade of the contract was at $96.00 it is an indicator that 96% of the market believes that the event is going to happen and the contract will end up in-the-money.

 

4) Learn the advantages of trading Binary Options over Traditional Options: Binary Options are generally easier to trade because they only demand a sense of direction of the price movement of the underlying asset whereas traditional options demand a sense of direction as well as the dimension of the price movement. No actual assets are ever bought or sold so the selling or shares and stop losses are not part of the process.

Binary Options have controlled risk to reward ratio which means that the risk and reward are pre-determined at the time the contract is acquired. Traditional options have no defined limits of risk and reward and therefore the gains and losses can be unlimited.

Binary Options provide nearly all the trading and hedging strategies that are possible while trading traditional options. Both fundamental and technical analysis strategies can be used to raise the accuracy of a price movement forecast.

Unlike a traditional option the payout amount is not proportional to the amount by which the option ends up in-the-money. As long as a Binary Option settles in-the-money by even one tick (regardless of how much in-the-money it is) the winner will receive the entire fixed payoff amount.

 

Binary Options offer contracts with short-term durations: In some markets Binary Options contracts close multiple times throughout the trading day while others may continue as long as a year. Some brokers are providing contract times of as short as thirty seconds. This provides the trader with a couple of investment opportunities and flexibility as markets change over time.

 

5) Learn where Binary Options are traded: Binary Options have been enormously popular in Europe and are often traded in major European exchanges like EUREX. In the United States there are a few places where Binary Options can be traded. The Chicago Board of Trade (CBOT) is offering Binary Options trading on the Target Fed Funds Rate. To trade these contracts you must be a member of the exchange or investors are required to trade through such members to execute a trade. The worth of each contract is $1000.

 

6) Check the implicit transaction costs of a Binary Option: Binary Options brokers do not charge any per-trade fees nor do they collect any commissions. What percentage of the time would you have to be correct to profit from the Binary Option you are watching? How different are the terms (for instance "strike price") for one side of the trade you are watching and the other side (or more precisely its reverse)? If they are far apart you would have to successfully predict that the underlying assets would move far from what the option-sellers predict (generally something between the terms which are offered for different sides of a transaction) which would be unusual to appear. It is extremely rare and difficult to out-guess the market consistently so high transaction costs can easily remove gains.

Below you will find a Binary Options Video which was designed to help you learn about Binary Options and to become a more knowledgeable trader. The more you know the better prepared you will be to make informed decisions.


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Risk Disclosure: Forex Directory will not accept any liability for loss or damage as a result of reliance on the information contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets. Currency trading on margin involves high risk and is not suitable for all investors. Before deciding to trade foreign exchange or any other financial instrument you should carefully consider your investment objectives, level of experience, and risk appetite.