What Are Binary Options?
Binary options, also known as digital options, are limited risk, short-term options where the trader will take a yes or no position on the performance of an asset during a set timeframe. At the conclusion of the option, the payoff will be all or nothing. Binary options provide traders with an avenue to trade the most popular; stock indices, currencies, commodities and stocks with minimal capital. Compared to traditional options, binary options are easier to understand.
Binary options are cash-settled options; in other words they can only be exercised on the expiration date, similar to European options. If a trader’s options closes “in the money,” they are paid a pre-determined amount of money. Likewise, if the trader’s options closes “out of the money,” they receive nothing. Binary option investors trade “on” the market versus “in” the market similar to other trading methods.
What Assets Are Able To Be Traded With Binary Options?
There is a wide assortment of binary option contracts available to traders. Traders are able to choose from:
• Indices: Dow Jones, Nasdaq, Nikkei, FTSE and more.
• Forex: Major currency combinations; USD, GBP, EUR, JPY, AUD and more.
• Commodities: Gold, silver, oil, coffee, corn and more.
• Stocks: A multitude of stocks are available including some of the largest companies in the world from a variety of industries.
What Are The Advantages Of Trading Binary Options?
• Binary options are usually less complicated to trade since they only require a trader to choose the direction of the price change unlike traditional options which require speculation of both the direction and the extent of the price change. There are no actual assets that are bought or sold and there are no stop-losses that are ever part of the binary options system.
• Binary options are limited risk investments with a pre-determined risk to reward ratio. The trader’s initial investment is the most that can be lost. Traditional options do not have a defined limit of risk which could be limitless. Binary options are considered controlled risks.
• Trading strategies used to trade traditional options are also able to be exercised when trading binary options. Binary options traders use; technical and fundamental analysis strategies to boost the accuracy of pricing predictions.
• Binary options require minimal capital and the payout amount is not relative to the amount by which the binary option ends up in-the-money. In other words, the trader will receive the whole fixed payoff amount if the binary option closes in-the-money, no matter by how much or by how little the option closes in-the-money.
• Most binary options contracts are short term; ranging from minutes to months. This offers the trader flexibility and nearly an unlimited amount of opportunities to make money.
How Do Binary Options Work?
Binary options contracts ask yes or no to a specific market question. For example; will the price of General Electric be above $30 at 11 AM? If the trader believes yes, they will buy the binary option contract; if the trader believes it is no, they will sell the contract.
When binary options are listed on the market, brokerages offer several expiration times to trade with.
• Intraday: times during the current trading day
• Daily: times within the next 24 hours
• Weekly: at the end of the current trading week
• Event-Based: at a set time in the future
The expiration value is obtained when a binary options contract expires. The value is determined using the following procedure based upon the underlying market.
Indices and Commodities:
1. Collecting the previous 25 trade prices in the underlying market
2. Removal of the five highest prices and the five lowest prices
3. Average the remaining 15 prices and round to one decimal past the point of precision of the underlying market (in most cases)
1. Collect the previous 10 midpoint prices in the underlying market
2. Removal of the three highest prices and the three lowest prices
3. Average the remaining 4 prices and round to one decimal past the point of precision of the underlying market
Market prices are acquired from mainstream data feed providers.
Binary options are European style, cash settled contracts. When left to the close of the contract, they are an all or none payout.
• If the provision of the contract is fulfilled, the settlement value is 100
• If the provision of the contract is unfulfilled, the settlement value is 0
There is a possibility of closing the contract before the expiration to recognize profits or to cut losses.
The strike price or target price of a binary option is the level of the market against which the option is settled. For example, in a ‘General Electric >$30 at 11AM’, $30 is the strike or target price.
What To Know Before Trading Binary Options
Binary options traders (especially beginners) should be aware of several details before starting to trade. By understanding these particulars, the trader will gain full knowledge of the brokerage and of the specific options they are preparing to trade.
• Know The Transaction Costs: It is difficult to continuously outperform the market. Options traders normally have to execute numerous trades to achieve a profitable position. Binary options brokerages do not charge commissions or per-trade fees however, it is imperative for the trader to be aware of the transaction costs since most profitable trading strategies will consist of many transactions.
• Know The Terms: Is there a significant difference on one side of the trade in comparison to the other side (IE: strike price)? If there is a substantial difference, the trader would need to predict not only the extent of change in value but also the direction of the change. Similar to traditional options, binary option positions are able to be bought or sold to close prior to expiration.
• Know The Two Possible Outcomes: The binary options trader should have some idea for the predicted direction in price of the asset. Most platforms are designed with two options called; “put” and “call”. “Put” is the expectation of a price decrease and “call” is the expectation of a price increase. Unlike conventional options; it is not required for the trader to speculate the degree of the price shift. The binary options trader must only predict the price of the specific asset as being higher or lower than the “target” (or strike) price at a set time in the future.
• Understand How The Contract Price Is Decided: Binary option contract pricing is determined by the probability of the event happening. For example, if a contract has a settlement value of $100 and the last trade of the contract was $95, it signifies that nearly 95% of the market expects that the event will occur and the contract will end up in-the-money. Traders of binary options pay for the option contract at the time of purchase.
• Understand The Percentages: Any binary options strategy (or any investment strategy for that matter) should include the required number of times a trader must be accurate to be profitable from the binary option they are considering. After the trader has recognized what the percentage is, they are now able to make a more informed decision to move forward or not.
• Decide Your Position: Research the current market conditions of your selected asset and decide if the price is probably going to rise or fall. If you are correct on the expiration date, you will receive the settlement value of the contract. The return rate on the investment is provided by the broker prior to the trader entering into the option contract.
• Learn Where The Binary Options Are Traded: Binary options are very popular in Europe and are largely traded on major European exchanges including the EUREX. There are also several exchanges in the US where binary options are traded; Chicago Board of Trade (CBOT) and the Nadex being among them.
The CBOT deals with binary options trading on the Target Fed Funds Rate. Traders are required to be members of the exchange in order to trade these contracts. Investors not part of the exchange must trade through a member. The value of each binary options contract is $1000.
The Nadex is a US regulated binary options exchange. The NADEX offers a spectrum of expiration possibilities such as; hourly, daily and weekly. This allows traders to take advantage of market developments with over 2,400 binary option contract choices daily. The extent of the options range from; popular currency pairs (EUR/USD) to commodities like oil and gold. Exchange member’s funds are securely held in a US bank account under the regulations of the CFTC.
ForexGator.com provides beginners and experienced traders alike with instructional guides in the learning center to develop your binary options trading strategies and techniques.
How To Start Trading Binary Options?
Choosing a brokerage is the first step for any potential trader. Every brokerage listed on ForexGator.com has been tested and verified in additional they offer bonuses to all new traders. After choosing the brokerage; traders will need to open a binary options trading account and fund the account prior to investing. The registration and activation of a binary options account only takes a few minutes and then investors will then be able to choose assets to invest in.