What are Binary Options?
A Binary Option is a financial option and considered a derivative of the underlying asset. The characteristics of Binary Options are that, the pay-off is either a fixed monetary amount or nothing at all. Hence the term “binary”, coming from the Latin and meaning that there are only “two” possible outcomes: either the trade pays off or it doesn’t. Binary Options differ from Classic Options, normally traded by Big Banks and Financial Institutions. Another characteristic, that is very specific to Binary Options, is that the trade is placed within a fixed timeframe. The trader is placing a trade on a certain outcome and that outcome has to play out within the chosen timeframe. One example follows. The trader decides to trade the EURUSD currency pair. According to his strategy he is also certain that this pair will move up. This would be a CALL-Option. In traditional Forex trading, this would be called “going long” or a “Long-Trade”. A move downwards and the corresponding trade would be called a PUT-Option (in regular Forex this would be a “Short-Trade”). Once the asset or commodity is decided and the direction, then the next decision is to choose from a series of timeframes. This is a critical decision, because the trader is basically saying that the EURUSD is moving up, before the corresponding time runs out. If the trader decided to trade within a 15-minute timeframe, then the EURUSD must be up from the moment the trade is placed and within the 15-Minutes. This can be tricky, since the trader needs to not only take the price fluctuation and the direction into consideration, but also the time setting.
In regular Forex or Stock trading, the time aspect isn’t so important. A trade can be floating and could be closed several hours or even days later and still make a profit (or a huge loss, depending on the trade setup). This is one of the advantages of Binary Options. The trader is not left to decide if the trade should go on for a longer time period. The trade is closed after the session ends (in the aforementioned example 15 Minutes). There is no “agonizing” over a trade that is going deeper and deeper into the red. If the trade is closed, the trader either wins a certain payout or he loses the complete amount. The payout can be anywhere from 50% to 500% of the trade amount. If a trader is investing 100 Euros and he was right with his analysis, then the payout could be anywhere from 50 Euros to 500 Euros. Doubling the trading bet is not unusual. If he wasn’t right about either the direction or the direction within the timeframe, then he would lose 100 Euros. The trading style and the methods need to be adjusted to this fast paced trading rhythm. The probability to reach a payout of 500% is very low and only a few brokers offer this kind of structured payout system.
The aforementioned example would be called a “High-Low-Option” and could be placed against Stocks, Indices, Commodities and Foreign Exchange pairs. This is also called a fixed return option. The timeframe is in reality called a strike price or an expiry option. The return is paid out, regardless of how much the instrument moved. This could be even 1 Pip or less. The point is, that the price must be above the strike price at the expiry time! For most financial instruments, the strike price is the current price rate – as traded in international financial markets – of the underlying financial product or asset class. Basically, the trader is deciding if the future price will be higher or lower than the current price, within a certain timeframe.
The expiry dates/times can go from 60 seconds all the way up to one day. Most traders play Binary Options within the 60-Minutes expiry time. This gives enough time to take a calculated risk and to place other trades – often following a hedging-strategy – and even to close the option before expiry time (some brokers allow for this kind of option, most don’t!).
Other than “High-Low-Options” there are also “One-touch-Options”. Here the price has to touch a certain price level, before expiry in order for the trader to make money. A “range-option” is a price range and the asset will need to fluctuate within this price range before expiry.
Binary Options are an exciting and innovative way to trade the financial markets. There are advantages and disadvantages to this kind of trading. Some traders like the fact, that all the factors are known at the onset of the trade. There are really no surprises. Either the trade is correct or wrong. This gives traders peace of mind. Another advantage are the fixed expiry times. A trader could take one hour or two and be done for the day, while other forms of trading might require several hours to analyse, observe and follow the trader. One of the disadvantages are the possibility to lose high amounts of money in a very short period of time. Good money management is paramount with Binary Options. Not everybody likes the fast-paced possibility to trade with very short time intervals (60 seconds), but some traders like this kind of setup and have the nerves to play Binary Options.
Another factor are the brokers. In order to trade with Binary Options you will need a good broker. Binary Options require a correct price feed and also fast execution times. Only professional Binary Options Brokers can provide the platforms, the software and the connection speed to avoid costly errors. Please refer to our list of Binary Options brokers to choose from a list of trusted Binary Options Brokers. Our website review team is constantly looking into the newest trends and the best Binary Options brokers.
You should not treat this as Gambling. Binary Options can be fun and quite exciting and this could lead to addictive behaviour. See our article about Trading versus Gambling. Are you treating Trading as a business or as a gamble?