What is a Binary Call Option

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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).

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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.

Binary Call Option Explained

The binary options trader buys a basic binary call option if he is bullish on the underlying in the very near term. This basic binary call option is also known as the common “High-Low” binary call option.

By purchasing a basic binary call option, the trader is simply speculating that the price of the underlying asset will be higher than the current market price when the option expires, typically within next few minutes or several hours.

It is entirely up to the trader how much he wishes to invest with each purchase of the binary call option. The minimum and maximum he can put in with each call option varies across brokerages.

Moneyness

If the price of the underlying is above the strike price of the binary call option, the option expires in the money and the trader stands to receive a payout. Otherwise, the option expires out of the money and he loses his initial investment.

In the rare event where the price of the underlying asset is exactly the same as the strike price, the option expires at-the-money and the trader will simply get back his original investment.

Limited Profit

If the binary call option expires in the money, the trader receives a profit which is equal to the payout% multiplied by the initial investment.

Limited Risk

If the option expires out of the money, the trader loses his initial investment. This is also the maximum he can lose in this trade.

Binary Call Option Example

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, the 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.

Binary Put Option

If the binary options trader is bearish on the price, he or she can buy a binary put option instead.

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. ]

Know When to Make a Call or Put

Binary trading has the real potential to lead to success. Once you have learned the ins and outs of how to trade binary options, there is no reason you can’t use your experience to profit.

The critical thing to remember about options trading, and one of its main advantages, is that it’s all or nothing. You either profit on the trade or you lose but, and this is what is making it so accessible, you know what you stand to win and what you could potentially lose before you place your trade and therefore you can always make calculated decisions.

You can usually only choose between two main options. Your choice when trading in this way is to pick between whether the current price of an asset will rise or fall within a set time. If your prediction is right, then success, you’ve made a profit, but if your prediction is wrong, then you have lost the trade. Binary options trading works on the premise that you choose between making a call trade or a put trade.

In this guide, you will learn:

    When to call vs put to ensure success The differences between using a call or put Why the importance of these two matters

Take your next step:

Call vs Put Decisions

Traders who execute binary options closely monitor financial news surrounding the asset they have in mind so they can identify any signals and determine if the asset is set to rise. The system can also work another way and can help you decide not to trade on an option due to a belief that its value will fall.

Call vs put is a simple way of representing different market positions and whenever you trade binary options, you will be choosing between put and call. As the trader, you should have control of all your trades and will need to be aware of all potential risks and rewards even before you enter any contract.

The simplicity makes binary options popular with new traders as well as experienced ones, and here we’ll be looking in more depth at the differences between call vs put trades and when you might choose each one.

Binary trading has the real potential to lead to success, once you have learned the ins and outs.

When to Make a Call

In simple terms, when opting for the call option you are selecting a choice with what is basically a safety net in place, this allows the owner to buy up a certain number of shares of an asset at a certain price level, often described as the strike price by a specific date, known as the expiration date/time.

Call options usually have to meet the following conditions: firstly, they must have an expiration date. Secondly, there must be a strike price, and thirdly there must be an actual underlying asset involved such as currency, commodity, stock or index.

For example, you may predict that the price of the stock of company X will rise from its current price which is $40 within the next hour. You will then decide to invest a nominal amount, perhaps $10 for this specific trade. If by the end of the hour the price has risen by even a single cent, you will win this trade. Your actual return will be your investment back plus the profit that the platform or broker is paying for winning trades. If it falls in value within the hour, you lose your trade.

When to Make a Put

A put option works oppositely to a call option. A put option means there is a safety net in place which allows the owner to sell a certain number of shares in an asset at a strike price by the expiration date/time.

Just like a call option certain conditions characterise a put option. There must be an expiration date, there must be a strike price and an actual underlying asset, as is the case of the call option.

Put options are based on you predicting if the price of an asset will decline in value within the time set by the expiration date. Using an example similar to before, you will make your prediction that the stock of company X will decrease by the end of an hour. You will once again stake a nominal amount, say $10, in this instance. Once again, if the price decreases even by a single digit, you will win the trade and receive your investment and the profit back.

Call or Put: You Decide

Binary trading depends upon the financial common sense and experience of how binary options work. Your expertise and understanding of the markets should guide your put or call predictions, ensuring they are more than likely to be correct. With the right research, you should almost always be able to correctly predict whether to make a call option or put option. With the guidance of your broker or signal provider, this should be easily manageable.

When making a put vs call, either can be used alone or combined to provide degrees of influence or protection for your portfolio. It is possible to use them as insurance to protect any gains made if they are looking unstable.

At the simplest level, calls are the right to buy, and puts are the right to sell. Using them wisely for the benefit of your profits is dependent on your skill and experience. No trade you make should ever be a guess, not even an educated one, and this is why the background work you carry out is integral to your success.

Jacob has been an author for us since our launch in 2020. He has over forty years’ experience in the financial sector and has held a variety of positions within financial services corporations and venture capitalist organisations.

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