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What Are Binary Options?

Binary options have been a popular form of investing throughout Europe and other countries for many years; however, this is a relatively new investment method in the United States. In fact, it wasn’t until 2008, when the listing of binary options was approved by the U.S. Securities and Exchange Commission that this type of investment gained interest among U.S. investors. However, after their initial introduction, the simplicity of this investment opportunity has continued to gain increased popularity.

 

What is a Binary Option?

For many people, understanding the basics of a binary option can help them make the decision if this is the type of investment that is right for them. The binary option is a specific type of option in which the investor is able to predetermine a fixed profit at the time of initiating the trade. If this binary option expires while “in-the-money”, the point where the market is over the strike price when the option was purchased, the fixed amount of preset compensation is paid to the investor; however, if the option expires “out-of-the-money”, or under the strike price, a preset loss or lack of profit will be incurred. Binary options are also commonly referred to as digital options or all-or-nothing options.

 

When considering the way a binary option works, it can be helpful to take a look at a simple example to demonstrate both the “in-the-money” and “out-of-the-money” possibilities.  In this example, if an investor chooses to purchase binary options for common shares in a company that is trading at a specific strike price, the binary payoff would be set and any gains would be received based on this predetermined point. However, this predetermined payoff or profit amount would only be paid if the stock was trading above the strike price when the option expired. On the other hand, if the stock was trading below this price on the date the option expired, there would be no compensation for the investor. In other words, when the conditions of the option are met the investor receives a fixed payout, either in the form of a set cash payment or other asset as determined by the option in question. Options expire according to the duration that is preset prior to their purchase.

 

Binary Options vs. Standard Options

Trading binary options is very different than trading regular options. For example, the investor who purchases a binary option can anticipate a specific payout based on small movements in the financial instrument. In fact, the investor will receive a fixed amount based on the market closing above or below a predetermined point. However, with standard options, an investor will typically not receive a payout unless there are large movements in the market.

 

With binary options trading, the primary goal is to be able to accurately predict how the price of an asset will move over the time of the option and where it will lie once the option expires. Binary options have a very all-or-nothing nature, but with good research they can also offer excellent profits. Additionally, because you can determine your potential profit at the start of the trade, this type of trading allows investors more control over their level of risk.

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Warren Stockton
 

Warren Stockton is an options trader and writes reviews on options courses, brokers and strategies.

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