Trading in binary options has become very popular in a short time. A lot of people even make a living from it. But what exactly are binary options? How are they different from normal options? And how can you make money with binary options? In this article we explore these questions.
Binary options (also called 'digital options' or 'all or nothing options') are a special type of options. (Are you not familiar with options? Please read the article 'what are options'.) As with ordinary options, binary options have an underlying asset, which can be a stock, but also, for example, gold, oil, the S&P500 index, or the US Dollar. How much you earn or lose with a binary option depends on the development of the value of the underlying asset.
The characteristics of binary options
Two key features of binary options are:
- The option is independent of the underlying product. When the option expires, it does not mean that the underlying asset will be delivered. You only get the amount of money agreed upon in the option paid out to you.
- There are only two possible outcomes (hence the name 'binary' or 'digital' options): up or down. It doesn't matter how much the underlying asset has changed in value. If the price at the time of expiration is above (or below) the opening price, the option pays out; If it is below (or above), the value is lost.
Given these characteristics, binary options are a lot simpler than 'regular' options (read also the article 'The difference between binary options and 'regular' options'). The moment you purchase a binary option, all important parameters are fixed:
- The moment the option expires ('expiration').
- The price above or below which the underlying asset should end ('strike price').
- Whether you bet on a price increase or a price decrease ('higher' or 'lower').
- How much the option pays out at profit (usually 80-90% on top of the amount risked) or loss (usually nothing).
- The amount risked.
Because all these details are fixed, the only question you must answer is: does the underlying product go up or down? If you are good at predicting this, you can make a lot of money with binary options. And since you can set exactly how much money you are willing to risk at the purchase of the option, you can never lose more than you want to.
An example of binary options trading
Suppose you believe that Apple’s share is currently overvalued at $672,81 and will fall in value during the next trading day, you can then choose a binary option on the share Apple Inc.(AAPL) to take advantage of the expected price drop. The option has the following characteristics at the time purchase:
- You choose an option with an expiration of 24 hours.
- The strike price is the current price of $ 672,81.
- You expect a price drop, so choose 'low'.
- This option returns a profit of 87% on top of the amount risked and 0 in case of a loss.
- You are willing to risk 50 pounds.
After you have closed the option, you do not have to watch the price any more. You can immediately focus on other options, or other fun things to do. The option expires automatically after 24 hours and the result is processed in your trading account. In this case, it appears that Apple shares initially rose slightly in value, but eventually fell to 670.24 U.S. dollars. That means you option was "in the money" at the time of expiration. You get 87% return on top of the amount risked, which means you get back 93.50 pounds; a gain of 43.50 pounds. Not bad!
Different types of binary options
There are some special variants of binary options (for example, 'touch/no touch' or 'boundary in/out') and some more advanced features (such as 'high yield' or 'early closure'). With those you have the ability to execute a more complex trading strategy. Would you like to know more about this, then please read the article 'Different types of binary options'.