Binary Option with Example explained

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What Are Binary Options Trading? – Binary Options Explained With Example

Binary Options trading are known for their simplicity and all-or-nothing nature. Moreover, a few reasons are behind to give this trading type name binary option. Options are derivative instruments. It can be traded as forex pairs, cryptos, stocks, indices, commodities, etc.

Furthermore, for traders, it is a lucrative trading type because of it’s quick and high return percentage. But, according to the research, binary traders should pay close attention to the rules of trading before diving with real money.

So, consider this article as a guideline for beginners and hence, we will keep it as simple as possible. Let us start with the binary definition first.

What Is Binary Options Trading?

Abe Cofnas is a thought leader and analyst in the financial industry. We took a line from his book to explain the actual meaning of binary.

“The binary option is called binary because it fits the condition of being either right or wrong-all or nothing.”

On the other hand, the exotic option allows a trader to speculate on the price movements of various instruments. To trade binary option, you don’t need to purchase an underlying asset.

You rather predict whether the price will increase above, or decrease below the strike price or purchase rate. The strike price is the price, at which traders trade underlying assets. Market price must increase or decrease, by the time the trade expires.

The expiry period for binary options is very diverse. The time frame starts from 30 seconds and lasts up to a year. After prediction the price, you will select the call or put option, depending on the asset price movement.

If you guess accurately, you win a payout. But the wrong prediction will give you nothing. It is required to mention that the payout rate differs from asset to asset and broker to broker.

Speaking of assets, there are multiple trading instruments that you can trade as binary options. Before selecting any pair, find some strategies and rules on how to trade binary options .

We will explain all the terms and facts of the binary option below that will give you more knowledge to understand.

Binary Option Trading Explained

Also known as digital options or fixed-return options, binary options belong to a special class of exotic options in which the payoff is either a fixed predetermined amount or nothing at all.

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For the common high-low binary option, the trader buys a binary call option if he thinks the price of the underlying asset will go up above the current market price or if he thinks the underlying asset price will go down, then he will buy a binary put option. If his assessment is correct, he will receive a payout. Otherwise, he loses the initial investment.

As binary options have fixed returns, it doesn’t matter how high or how low the price of the underlying has moved past the strike price. The payout is also fixed and known prior to entering the trade. Also important to note is the fact that the payout for a successful binary trade is usually only about 70% to 80% of the investment put into the trade.

Binary options also typically have very short expiration times ranging from as fast as 60 seconds to just a few weeks.

Example of a Typical Binary Option Trade

A binary options brokerage is offering 85% payout for the binary call option on EUR/USD which is currently trading at $1.30.

After tracking the price movement of EUR/USD for the past hour, a binary option trader believes that the price will rise over the next 5 minutes and decides to invest $100 to purchase a binary call option on EUR/USD expiring in the next 5 minutes.

If EUR/USD goes up to say $1.31 five minutes later, the investment pays off and the traders earns a profit of 85% of his initial investment, which is $85.

However, if the price of EUR/USD drops down to say $1.29 instead, the trader will have lost his initial investment of $100.

Note that it does not matter whether the price of EUR/USD skyrocketed up to $1.40 or flash crashed below $1.00, both the profit and loss will be fixed at $85 and $100 respectively.

Continue Reading.

What are the Main Types of Binary Options?

Learn how the One-Touch, No-Touch and Range/Boundary binary options differ from the common high-low viety and how to trade them. [Read on. ]

What Assets can be Traded using Binary Options?

Many of the most popular financial instruments such as currency pairs, equities and commodities are available to trade using binary options. . [Read on. ]

Binary Options: Trading or Gambling?

Is binary option a legitimate financial instrument or just another form of gambling. [Read on. ]

Binary Options & Trading Robots: A Perfect Match?

Unlike humans, robots have no emotion and do not need to rest, so they can make a lot more trades than humanly possible, combined with perfect consistency. [Read on. ]

Is Binary Options Trading a Scam?

Learn how you can get scammed when trading binary options if you are not careful. [Read on. ]

How to Select a Binary Options Broker?

With so many scam brokers out there, before you learn how to trade, one must know how to separate the wheat from the chaff and find a trustworthy binary options brokerage. [Read on. ]

Binary Options: Calculating Breakeven Win-Rate for a Given Payout

How often does my trades need to be successful in order to be consistently profitable in the long run when trading binary options. [Read on. ]

Binary Option

What is a Binary Option?

A binary option is a financial product where the buyer receives a payout or loses their investment, based on if the option expires in the money. Binary options depend on the outcome of a “yes or no” proposition, hence the name “binary.” Binary options have an expiry date and/or time. At the time of expiry, the price of the underlying asset must be on the correct side of the strike price (based on the trade taken) for the trader to make a profit.

A binary option automatically exercises, meaning the gain or loss on the trade is automatically credited or debited to the trader’s account when the option expires.

Binary Options Outside the US

Basics of a Binary Option

A binary option may be as simple as whether the share price of ABC will be above $25 on April 22, 2020, at 10:45 a.m. The trader makes a decision, either yes (it will be higher) or no (it will be lower).

Let’s say the trader thinks the price will be trading above $25, on that date and time, and is willing to bet $100 on it. If ABC shares trade above $25 at that date and time, the trader receives a payout per the terms agreed. For example, if the payout was 70%, the binary broker credits the trader’s account with $70.

If the price trades below $25 at that date and time, the trader was wrong and loses their $100 investment in the trade.

Key Takeaways

  • Binary options depend on the outcome of a “yes or no” proposition.
  • Traders receive a payout if the binary option expires in the money and incur a loss if it expires out of the money.
  • Binary options set a fixed payout and loss amount.
  • Binary options don’t allow traders to take a position in the underlying security.
  • Most binary options trading occurs outside the United States.

Difference Between Binary and Vanilla Options

A vanilla American option gives the holder the right to buy or sell an underlying asset at a specified price before the expiration date of the option. A European option is the same, except traders can only exercise that right on the expiration date. Vanilla options, or just “options,” provide the buyer with potential ownership of the underlying asset. When buying these options, traders have fixed risk, but profits vary depending on how far the price of the underlying asset moves.

Binary options differ in that they don’t provide the possibility of taking a position in the underlying asset. Binary options typically specify a fixed maximum payout, while maximum risk is limited to the amount invested in the option. Movement in the underlying asset doesn’t affect the payout received or loss incurred.

The profit or loss depends on whether the price of the underlying is on the correct side of the strike price. Some binary options can be closed before expiration, although this typically reduces the payout received (if the option is in the money).

Binary Options and Regulation

Binary options occasionally trade on platforms regulated by the Securities and Exchange Commission (SEC) and other regulatory agencies, but most binary options trading occurs outside the United States and may not be regulated. Unregulated binary options brokers don’t have to meet a particular standard; therefore, investors should be wary of the potential for fraud. Conversely, vanilla options trade on regulated U.S. exchanges and are subject to greater oversight.

Real World Binary Options Example

Nadex is a regulated binary options exchange in the United States. Nadex binary options are based on a “yes or no” proposition and allow traders to exit before expiry. The binary option’s entry price indicates the potential profit or loss, with all options expiring worth $100 or $0.

Let’s assume stock Colgate-Palmolive Co. (CL) is currently trading at $64.75. A binary option has a strike price of $65 and expires tomorrow at 12 p.m. The trader can buy the option for $40. If the price of the stock finishes above $65, the option expires in the money and is worth $100. The trader makes $60 ($100 – $40).

If the option expires and the price of the Colgate is below $65 (out of the money), the trader loses the $40 they put into the option. The potential profit and loss, combined, always equals $100 with a Nadex binary option.

If the trader wanted to make a more significant investment, he or she could change the number of options traded. For example, selecting three contracts, in this case, would up the risk to $120, and increase the profit potential to $180.

Non-Nadex binary options are similar, except they typically aren’t regulated in the United States, often can’t be exited before expiry, usually have fixed percentage payout for wins (whereas Nadex payouts fluctuate based on the price paid for the option) and may not trade in $100 increments.

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