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A binary option is a type of option where the payoff is all or nothing, making them simpler to understand and trade than traditional options with a wide array of possible payoffs. The two main categories of binary options are the “cash-or-nothing” binary option and the “asset-or-nothing” binary option. The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. Thus, these securities are called “binary options” because there are only two possible payoff outcomes. They are also called all-or-nothing options, digital options (common in forex trading) and fixed return options (FROs) (on the American Stock Exchange). Binary options are usually European-style options which means they can only be exercised on the date of expiration. For example, let’s go through an example where a binary cash-or-nothing call option is purchased on XYZ Corp's stock struck at $100 with a binary payoff of $1000. Then the stock is trading at or above $100 on the expiration rate, $1000 is received. If its stock is trading below $100, nothing is received. How do you begin trading binary options? Let’s review the basic steps to understanding and correctly trading this potentially powerful hedging and speculation instrument: 1) Decide on the direction of the underlying asset. In order to make an educated decision on binary options trading, the trader first needs to anticipate the direction of the price movement of the underlying asset. The directional choices with any option, including binary ones, are called put and call. Put is the prediction of a price decline, while call is the prediction of a price increase. Unlike traditional options, knowing the magnitude of the movement is not required. Instead, one must only be able to correctly predict whether the price of the chosen asset will be higher or lower than the starting price. 2) Position your binary options trade wisely. The price of a Binary Options contract is equal to the probability of the event happening. For example, if the contract value has a value of $100 and the last trade of the contract was at $96.00, it is an indicator that 96% of the market believes that the event is going to happen and the contract will end up in-the-money. The more the risk or the lower the likelihood of an outcome occurring, the greater the reward associated with betting on it. An intelligent investor understands and weighs each potential trade on these two considerations before taking a position in a contract.Evaluate the current market conditions surrounding your chosen asset and determine how you want to position your trade. If your insight is correct, on the expiration date, your payoff is the settlement value of your contract. The return rate on each winning trade is decided upon by the broker and this amount is always made known upfront. 3) Know when to get out of a position Successful traders don’t hesitate to take corrective action when they believe that their binary options contracts will end out-of-the-money at expiration. As an example, let’s say you have a $75.00 Silver contract that you believe will expire out-of-the-money at expiration. Instead of holding it until expiry and losing your entire investment, selling it at $30.00 and neutralizing your open interest will help you mitigate the loss (i.e. $45.00 instead of $75.00). 4) Beware of hidden costs Screen several binary options brokers before making a selection. Each broker is going to provide their own trading platform, contract times, assets, return rates, and educational resource, which of which will have an impact on your trading returns. Many binary options brokers do not charge any per-trade fees, nor do they collect any commissions. What percentage of the time would you have to be correct to profit from the binary option trade you are considering putting on? How different are the terms (for instance, "strike price") for one side of the trade you are contemplating and the other side? If they are far apart, you are predicting that the underlying assets will move substantially far from what the option-sellers predict, which is a rare and unusual occurance. Out-guessing the market consistently is incredibly difficult, so high transaction costs can easily hurt or eliminate returns. Enjoy this article? Read more educational articles for traders and community reviews of trading tools at Top Trading Software reviews.
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