Binary options are investments that allow a trader to place a bet on an asset exhibiting specific price behaviors or not. Other terms are “digital options” and “fixed return options.” Some traders call them “all-or-none” options. Either the investor is “in the money” and gets everything or “out of the money” and gets nothing.
Two Possible Outcomes
“Binary” refers to the fact that there are only two outcomes: all or nothing. Binary option pricing is presented as an index. The index goes from 0 to 100. If the possible outcome takes place, the option is settled at 100. If the potential outcome does not happen, the option finishes at zero.
A broker places a price on the potential outcome. If the trader thinks this outcome will take place, they can buy the bet. If they don’t believe the outcome will take place as outlined, they are in the position of selling the bet.
Binary options are sometimes best explained with an example. Suppose Yahoo! (YHOO) is currently at $25 a share. An investor believes it will close at or above $30 within 7 days. The investor buys 10 YHOO binary options at a price of 40 cents. Since the multiplier is 100, 40 cents multiplied by 100 = $400.
If YHOO closes at $30 or more by the end of the binary option closing date, it is valued at $100, so 10 YHOO call options are valued at $1000. Total profit equals $600. It does not matter if YHOO finishes at $30, $35 or even $45. As long as it closes at $30 or above by the expiration date, each option is valued at $100. However, if YHOO were to close at $30 or below the option has no value.
Settled at the End
Binary options can only be settled at the end of the expiration date. Distinct from calls and puts, they do not have prearranged prices. The investor determines how much he wants to bet. He then places that much when he purchases the option. If the price is 15 cents, he can make 85 cents if the underlying action changes as much as the investor believes.
The length of expiration for binary options is determined at various time intervals. For example, one hour, one day, or even one month are typical option expiration time lengths. They have short durations which makes them appealing to investors who enjoy taking risks.
Here is another simple example. Apple (AAPL) is selling at $450 a share. An investor thinks the price will go to $475 within the next 60 minutes. They invest in a “call” which simply means they think the price will rise. At the end of 60 minutes if the price has gone up to $475 or more, they win. If the price is below $475, they lose.
There are two main categories of binary options. Investors can purchase a cash-or-nothing option or asset-or-nothing. Cash-or-nothing provides a fixed payout if the option finishes in-the-money. The asset-or-nothing choice gives the investor the value of the inherent security.
Set in Advance
The possible return of the binary option is set in advance and communicated to the investor before they buy it. Options provide investors the choice of betting long or short on a wide variety of financial products. Each option has a fixed time period in which it expires. Once an investor purchases an option, they cannot resell it before the end of the expiration time.
A growing form of binary options is known as “touch/ no touch.” Some investors call them “one-touch” options. Investors predict that a stock will “touch” a certain level in the period in which trading takes place. If the stock “touches” the predetermined level, the investor earns a 60-70 percent gain. On the other hand, if the stock does not touch the predetermined range by the end of the set trading time, the investor loses 85-100 percent of the investment.
Binary options provide many benefits for certain investors. A major benefit is they give people instant gratification. Unlike long-term investing, binary options provide fast action. In addition, they are simple. You don’t need an MBA from Harvard to understand them.
They are also very flexible. Investors can trade commodities, Forex and more. Finally, binary options are very scalable. The risk is minimal, Investors can put their toe into the options pool without the fear of losing a lot of money.
Binary options have grown more popular in recent years. They were originally offered on only a few limited products and exchanges. As increasing numbers of investors bought them, more exchanges offered a variety of creative options. Due to their simplicity, scalability and quick turnaround, they will continue to grow in popularity. As exchanges offer more ways to invest in binary options, traders are sure to utilize this fast-paced investment to an even greater extent.