How do Binary Options Work

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How to Understand Binary Options

Updated: September 6, 2020

This article was co-authored by Michael R. Lewis. Michael R. Lewis is a retired corporate executive, entrepreneur, and investment advisor in Texas. He has over 40 years of experience in business and finance, including as a Vice President for Blue Cross Blue Shield of Texas. He has a BBA in Industrial Management from the University of Texas at Austin.

There are 7 references cited in this article, which can be found at the bottom of the page.

A binary option, sometimes called a digital option, is a type of option in which the trader takes a yes or no position on the price of a stock or other asset, such as ETFs or currencies, and the resulting payoff is all or nothing. Because of this characteristic, binary options can be easier to understand and trade than traditional options.

What Are Binary Options & How do They Work: Complete Guide

Binary options are a straightforward form of derivatives that differ slightly from vanilla options and convey fixed profit/loss and risk to investors. Binary options present a simple question of whether or not the price of the underlying asset will be above or below a strike price at a point in the future.

Most binary options trading occurs outside of the U.S. as they are strictly regulated by the Commodities Futures Trading Commission (CFTC) and are only available in specific formats on regulated exchanges in the country.

Binary options are simple methods for hedging risk or speculating on the price of multiple forms of assets with a predetermined risk and potential for profit or loss. However, many binary options are considered gambling or fraudulent, which is why they are strictly regulated in the U.S., and illicit outlets are pursued by FBI worldwide.

Several outlets for cryptocurrency binary options are available. However, they are not recommended for beginners as they carry high risk and are involved with an emerging asset class that is still undergoing regulatory maturity. Facebook, Google, and Twitter all banned specific binary options advertising along with cryptocurrency ads last year.

Difference Between Vanilla Options and Binary Options

Financial options are derivatives contracts that offer an investor the right to buy or sell an option representing an underlying asset at a strike price at a specific date. Investors are not obliged to buy or sell the option; they only receive the right to do so at an agreed upon price. Investors can profit or sustain losses on the difference in the price of the asset compared to the strike price.

American and European options differ in one significant measure. Traders of American options can buy or sell the option any time before the expiration date of the contract while European traders have to wait until the expiration of the contract to exercise the option. In American options, traders can exercise the option before the expiration of the contract to lock in profits or minimize losses, however, profits are usually reduced if the contract is exercised before expiry.

Options are great for increasing earning potential without buying on margin or borrowing. Vanilla options enable investors to actually own the underlying asset in the derivative contract, and profits/losses vary depending on the extent of movement of the asset’s price.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Top Binary Options Broker 2020!
    Perfect For Beginners and Middle-Leveled Traders!
    Free Education How To Trade!
    Free Demo Account!
    Big Sign-up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!

Binary options differ from vanilla options in that traders are not given an opportunity to hold a position in the underlying asset. Instead, profits and risk are typically fixed on a per option basis — the overall profits are not affected by the extent of movement in the underlying price of the asset, only whether or not it was above or below the strike price.

How Binary Options Work

Mot binary options are traded outside of the U.S., and they can be used as speculation for a suite of assets such as stocks, bonds, commodities, and currencies. They are very straightforward but contain nuances depending on the broker and in what jurisdiction you are trading.

For example, binary options trading via a regulated American exchange would work as follows for a forex option.

If Exchange A offers binary options in the U.S., all the options would either expire at $100 or $0 with traders capable of exiting before the expiry of the contract. A binary option presented to a trader for the EUR/USD trading pair would be:

“Will EUR/USD trade above 1.2000 at 12 AM on April 1st, 2020?”

Traders can either choose to buy or sell the option. If they buy, then they expect the price of the EUR in USD to be above 1.2000 at 12 AM on April 1st, 2020. If they sell, then they presume the price of EUR in USD will be equal to or below 1.2000 at the contract’s expiration on April 1st, 2020.

If Alice expects the EUR/USD pair to be above 1.2000 at the expiry date, and the current ask price is $40 for the option, she can buy the option contract for $40. If the EUR/USD pair trades at higher than 1.2000 at the expiration date, then Alice’s contract is now worth $100. Subtract her $40 from $100 and her profit is $60. If the pair trades below 1.2000 at the time of expiration, Alice loses her $40.

In American options., Alice can exit her position before the April 1st, 2020 deadline — in European binary options, she cannot. For reference, not all binary option outlets operate with $100 binary options, but that is the standard and is what U.S. binary exchanges like Nadex use.

Alice could even acquire multiple binary options for her position. So, if she bought 3 of the same trading pair options, her cost would be $120 for a potential profit of $180.

Notably, Alice’s losses will never exceed the amount she spent on the option (i.e., $40), presenting a discernable risk/reward ratio before making the trade. Her profit or loss does not depend on the extent of the trading pair’s movement, only that it is above or below a certain threshold — payouts are fixed.

Binary Option Brokers

There are a few brokers which offer Binary Options trading, perhaps the most well known is IQ Option, which we have covered before on Blockonomi.

Before deciding to trade Binary options, you should make sure you are well aware of the risks involved, it’s possible to quickly lose money due to the leverage involved. They are not for beginners. You should also be aware of the laws surrounding them in your country – the brokers will let you know whether your country is covered.

Here are the brokers we have reviewed:

Advantages of Binary Options

Binary options are straightforward and excellent for traders who wish to engage with various asset markets with a fixed risk and reward before trading. Binary options are typically used for speculation, but can also be used to hedge risk.

American options are more ideal as they allow traders to exit their position before the expiration of the contract, but most binary outlets around the world do not permit exiting before contract expiration. The U.S. binary exchanges are regulated by the CFTC, and the leading exchange for binary options is Nadex — based in Chicago.

The fixed risk of binary options is their critical advantage. Risk management can be a stressful and complicated ordeal in broader financial instruments and markets. Pinpointing risk and control clarifies speculation opportunities for traders not looking to deal with more complex financial vehicles.

Disadvantages of Binary Options

Regulation of binary option outlets is fragmented, and the onus is on traders to do their own research and properly vet binary option exchanges outside the U.S. Many governments classify binary options as high-risk and unpredictable — akin to outright gambling.

Binary options trading is banned in Israel, and the European Union banned binary options for retail traders last year and recently extended the ban.

In general, binary options carry considerable risk, no matter what jurisdiction or exchange used. Tightly regulated exchanges in the U.S. are the most cautious move for trading binary options, and trading outside the U.S. is hazardous for retail investors.

Binary options involving cryptocurrencies and digital assets are even more precarious as they are not regulated, cryptocurrencies are highly volatile, and the industry is already predisposed to endemic fraud and scams.

Conclusion

Binary options are a simple proposition for market speculation of diverse assortments of assets but carry inherent risks. The ability to discern precise risk/reward degrees from trading with binary options is useful for traders looking for a straightforward investment tool. However, trading binary options should be consigned to tightly regulated exchanges in financially prudent jurisdictions.

How Trading Binary Options Makes You Money

Binary options may be one of the simplest and easiest ways to trade. These options offer the opportunity to make a prediction on the value changes on the assets at the end of a specific period of time. The asset could be stock, indices, or commodities. As the trader, you simply predict how the asset will move during a defined period of time.

Binary options are also called “all-or-nothing” options. If you accurately predict the movement of the asset within a set period of time, you are paid a fixed return on your investment. You lose your investment completely if the asset does not perform as you expected. The term binary refers to something that has two parts. In this case, there are only two possible outcomes to the investment – win or lose.

How Do Binary Options Work

The most common type of binary option is the high/low option. Let’s assume that you select a binary option in the gold market. You believe the price of gold will increase within the next 6 days. This is referred to as a “call option”. If you believe the price of gold will decrease within that timeframe, you are investing in a “put option”. You will receive a payout of a predetermined amount if you correctly predict whether the price of gold will increase or decrease at the expiry.

Although the high/low option is the most common, there are other binary options available to traders outside of the United States. The “one-touch” option allows the trader to select a specific target price that the asset needs to hit at any point during a specific timeframe. With range options, traders select a price range at which they believe the asset will trade before the expiry.

Make Money with Binary Options

The profits you can achieve are based on your ability to accurately predict the movement of the asset. By accurately determining the movement of the asset, you can make a profit with binary options. The amount is based on the predetermined return rate.

How to Trade Binary Options

Learning how to trade binary options is as easy as choosing a broker, selecting an asset, deciding how much to invest, and determining the expiry. Binary options are a fast-paced, exciting way to trade but they are also simple and easy to understand for new investors.

Choose a Broker

There are many binary options brokers available. A good binary broker will help you to earn more profit. Be sure to check for new investor incentives before you join any broker. Fees and returns on the options vary by a broker, as does the minimum and maximum amount for trades. Be sure to check these details for each broker you consider.

Select an Asset

Unlike other types of trading, binary options allow the trader to make predictions on the asset, instead of purchasing the underlying asset. Traders can select from commodities, indices or stocks. Once determining which type of asset you are interested in, you can then decide to invest in a call option or put option.

Decide How Much to Invest

Each broker’s policies will outline the minimum and maximum trade. Typical trade ranges are from $10 to $10,000 but will vary by broker. When you determine how much to invest, the broker will provide the exact return on the option you selected.

Determine the Expiry

To determine the time-frame for a binary option, you will need to consider the market conditions ,as well as its impact on the price of the asset. Time-frames can vary from minutes to months depending on the types of assets you choose.

Find a Good Binary Options Signals Service

In order to maximize the potential of getting profit, it is advised to check out a binary options signals service. Basically, this type of service will inform you when a profitable trade is available; e’ve listed a few of the best signal providers here: https :// www . personalincome . org / best – binary – options – signals /

How to Play Binary Options

Many brokers and trading platforms allow for a demo period prior to placing live investments. Investors are offered play money to practice their investments. You should take full advantage of these demos prior to going live. You will get a feel of how the platform works, how does binary trading work even before you put up any real money.

Conclusions

If you’re interested in fast-paced, simple trading, then binary options may be the right choice for you. Learning how does binary options trading work is straightforward and easy to understand. Binary options are all or nothing, so there’s always risk involved. But these options offer a simple trading opportunity even for the newest of traders. With some understanding of how do binary options works, I believe you can make the right decision, whether binary options trading is for your or not.

Editor’s Note

If all this spells too much risk for you, then you may best stick to stocks trading. We also suggest subscribing to trading veteran John Thomas’ Trade Alerts, wherein you’ll be cued on what to buy and what to sell and the best time to do it. Sign up below and you get to use his smarts to make yourself a killing.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Top Binary Options Broker 2020!
    Perfect For Beginners and Middle-Leveled Traders!
    Free Education How To Trade!
    Free Demo Account!
    Big Sign-up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!

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