What a Binary Option is ?
Binary options are options to invest on the realization of a condition on the expiry of the option. At maturity, if all conditions are met, the investor receives a fixed premium predefined in advance. So it is a contract between the seller of the option (the broker) and the investor.
The gain is a percentage of the amount invested. This percentage is around 80%. The potential gain is therefore known in advance. However, if the conditions are not met at maturity, the amount invested is lost entirety. These options are also called options "all or nothing. "
The advantage of binary options as opposed to traditional options is that it is not necessary that large variations occur to win the premium. Indeed, binary options are constructed to capture small price movements and therefore, maturity dates can be very close. So you can find binary options with a maturity of one hour or 15 minutes but also find options with maturities much longer, ranging from day to week.
Binary options are bought at the money. This means that the strike of the option is the purchase price of the option. In other words, if the price changes of only one pip in the right direction, you earn the option premium at maturity.
Binary options allow speculating in many markets like Forex, equities, commodities and indexes.
Types of Binary Options
There are 4 main types of binary options:
- Cash or nothing (all or nothing, High / Low): This is the most popular binary option. You are speculating on the fact that the price will be at maturity of the option above or below the strike. We speak of a call (option to purchase) if the investor anticipate the rise of the price and a put (option to sell) if the investor anticipates the fall of the price. When you buy the option, the asset price is equals to the strike of the option. The binary option is then in the money. If you bought a call and at maturity the price of the underlying exceeds the strike of the option, you receive the premium which is about 80% of the amount invested. However, if the price of the underlying is below the strike of the binary option, you lose all your money (some brokers will give you back 10% of your investment in some cases). Such options is a way to play the trend
- One touch (Hit): The principle is the same as cash or nothing options except that the option can be disabled before the option’s maturity if the strike determined in advance is reached. The investor thus speculates that the price will reach the preset area during the lifetime of the option. If the price is not met, the investor loses his bet. However, if the area is reached, it will gain about 80% of its investment. This type of option allows to play the volatility of the underlying. They can be a good investment, for example during a major economic announcement.
- Hit or Miss: The investor then speculates that the price will reach or not a certain level. If the level is reached and if the investor trades this fact, then he earns the premium. It can also play that a certain level will not be reached. If so, then it will receive the premium.
- Range: to earn the premium, the price must remain within a predetermined area. There is therefore a low threshold and high threshold. If at maturity the price is not moving within this area, then the investor loses his bet. This type of option allows you to play a low volatility of the underlying.
Binary options advantages
Here is a comparative table between binary options and standard options:
Minutes, hours, days, weeks
At all time
At maturity (except for a one touch option)
Rights to buy
- The principle of binary options is very simple. There is no complicated formula that determines the evolution of the option price
- The risk is controlled: You know in advance the exact amount that you risk, namely the amount invested. This makes it much easier to manage the concept of money management as opposed to standard options.
- Quick profits: In a few minutes, it is possible to have a payback of about 80%.
- Fixed profits : Profits are not based on the price of the underlying at maturity. Only whether or not if the price is above or below the strike of the option.
- Possibility to negotiate all assets on a single platform. Indeed, binary options allow you to speculate on many markets like Forex, equities, commodities and indexes.
- Allows you to trade the volatility and the trend on many underlying
- Binary options can be trade 24h/24 and 7d/7 with some brokers
- Trading platforms for these options are often very clear and easy to use.
- Small price variations can make you win a lot of money