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What is binary Option?

Your capital may be at risk. This material is not investment advice.
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Written by trading expert:Professional Day Trader
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Short resume:
  • Author of the book Options Trading for beginners
  • Worked in finance in 12 years
  • Got a MBA in Finance, BA, International Business Administration And Marketing
  • Built a solid record of achievements through constantly developing financial markets
  • Traded on the most frequently utilized stock exchanges: TSE, LSE,NASDAQ, NYSE, Euronex Actively managed a 6-9 million dollar portfolio
  • Developed new and innovative trading systems and implemented them during trading hours
Matthew O'Connor is the author on the bestseller Option Trading for Beginners
Option Trading for Beginners - Written by Matthew O'Connor

The word ‘Binary’ has two meanings. In the term Binary options, it is used to mean that only two options or scenarios exist. This is therefore a trading format in which investors are given options that will either lead to a win of a pre-determined monetary amount or no win. The direction in which a product is moving in the market determines the profit during a Binary options trading.

In Binary options markets, the trader or option holder is not given the right to sell or buy the asset in question. In fact, their proposition is entirely yes-or no-based. For example, an option holder can be asked to foresee the direction the price of an asset will take at a pre-determined point in time. In this case there are only two options; it will either be lower than a certain amount or higher at the said time.

How do Binary Options Work?

Binary options differ from traditional options of trading due to their design that involves only two outcomes under consideration. They are therefore one of the most preferred ways of trading the fluctuations in prices in multiple markets.

The “high-low” or fixed-return option is the most popular Binary option. This option provides access to foreign exchange, commodities, indices and stocks. The success of an option holder is based on whether they have waged correctly on the direction of the market and not the degree of movement of the asset. An exercise (strike) price and an expiry time or date are preset to determine this. A wage is paid out if at the expiry of the trade the price of the underlying item is at the foreseen side of the exercise price. If you choose an ‘out of the money’ option you win nothing, hence the term “all-or-nothing” option.

A binary option is a common type of Binary option with a call/put or up/down option. As a trader, you buy a call (up) if you predict that the underlying price will go up. But if you believe the contrary, then you buy a put (down). The expiry, exercise price, risks and payout are all revealed before the trade begins. To be compensated for a call, the price you predicted must fall over the exercise price when the time expires. If you bought a put and indeed the market falls, you are only compensated if the price is below the exercise price at expiry.

Typically, binary options traded on U.S exchanges differ from those outside the U.S in their structure. The exercise price for many high-low binary options in foreign countries is the specific stock, USD/EUR currency pair, or the S&P 500 index. The wager, therefore, is about what the bargain price at expiry will be (lower or higher) when compared to the price at the beginning.

Another difference that foreign digital options have with digital options in the US is that they are not offered by an exchange. Instead, there are brokers who capitalize on the difference created when an investor loses and when they win a wager.

 

An Example of High-Low binary Option Trading:

The price of organic common oranges is $12. You can purchase a one day binary call option for a one day contract if you predict that the price will be above $12 by the same time tomorrow.

Think about your investment (the amount of money you put in). If the payout is 50% and you put in $30, you will get $40 if you win. But your investment will also be the risk you take since you can lose your $30 if the price dips below $12 at the expiry of the contract.

Other Types of binary Options

As binary options become more popular and competition heightens, more products are being unveiled by brokers.

A ‘one-touch option’ is a type of binary option where the trader predicts an amount they believe the item will be traded at before the close of the trading period and another amount they believe it will not be traded at. If your prediction is right and the price does not touch the level you projected, you are compensated.

There is also a ‘double touch’ binary option that requires one to choose two prices that they predict will be traded at. Although this is a range of prices, both of the prices must be touched for you to receive your compensation.

Another binary is a ‘range’ where traders are allowed to select a price range that the asset will trade with until the close. You receive compensation if the price stays at the range you predicted, but lose your investment if the price goes above or below the predetermined range.

The closing price is irrelevant with all types of binary options trading. Traders often feel that the prices of certain assets are highly volatile. For these underlying assets, an investor will be able to trade comfortably when they have a range of value that they believe the price will remain at.

What Makes binary Options Trading Attractive?

With binary options trading, the only important decision to make is the direction that the market is taking. This is different from other forms of trading where the size of a price movement can also affect your success.

binary options give traders an overview of their risk-to-reward option since everyone gets a similar payout as long as they have made a winning wager. This also differs from traditional options that give limitless profits and losses.

The flexibility of binary options is another plus for them. There is a flavor of underlying assets to trade in from indices like S&P 500, FTSE, company shares, commodities and even foreign exchange. There is also flexibility in the time period of contracts from as low as 30 seconds to as much as several months. This gives one the freedom to choose their contract based on their trading style and expertise.

Experienced traders who have knowledge on fundamental and technical analysis from other markets can use these skills in binary trading.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future. In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.
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