You may have heard the term “binary options”, wondering what are binary options, and why they are becoming so popular nowadays. Maybe even one of your friends is currently trading binary options, or you might have seen a video or advertisement about binary options trading stating that you can get rich overnight (or something like that) by trading binary options only a few minutes per day. The fact is that many traders have decided to step inside the binary options trading, attracted by this new type of financial option. Let’s see what binary options are and how they can be used by traders to speculate in the financial markets.
What are the binary options: how they work
Binary options are a simple financial product which allows investors to choose basically whether an asset will go up or down over a prescribed period (called “expiry time”). Said in other words, a binary option is a type of option in which the payoff can take only two possible outcomes, either some fixed monetary amount (or a precisely predefined quantity or units of some asset) or nothing at all (in contrast to ordinary financial options that typically have a continuous spectrum of payoff). That’s why binary options are often called “all-or-nothing options”.
Therefore, a trader that would like to invest in binary options trading has to make a prevision on the future movements of the price of an asset (chosen by the trader among shares, stock market indices, commodities, forex currency pairs). The value of an asset can only increase or decrease over time, so the trader has “only” to decide if there will be a rise or a drop in the asset’s value during a certain period of time (the so-called “expiry”). If, after the expiry time, his prediction will be right, the trader will receive the “Payout” (aka profits). Otherwise, the trader will lose the capital invested in that particular binary option. Even though, sometimes the trader can receive a small amount of capital back as a refund (around the 10-15% of the amount invested in the binary option).
The Payout entirely depends on the “settings” of your binary option. Indeed, a trader can choose the asset, the expiry time, and the type of binary option (because yes, there are different types of binary option). A lot of traders decide to trade binary options especially for their flexibility as a financial product and for their low level of risk, too. In fact, when you trade binary options, you will always know the amount of money you can earn (Payout) and lose (Loss) by investing in a binary option. Even before placing your order, you already know these two fundamental information, making it easier for you to plan a good money management strategy (something you surely need if you want to earn in the long-run). In the other financial markets, like the stock market or the forex market, when you open a position you will never know the exact amount of profits or losses. Another reason why binary options are the financial instrument of choice for many beginners traders.
As we said earlier, there are different types of binary option. Depending on the binary option you choose, the Payout will be different (higher or lower). The following ones, are the most common types of binary option that you can trade:
- Binary options high/low: also known as “binary options call/put” or “binary options up/down”, are the most traded type of binary options. A trader has to make a prevision if the price of an asset will increase or decrease over a period of time (expiry time). If the prevision is right, the trader will earn the Payout. Otherwise, the trader will lose the capital invested in the binary option.
- Binary options one touch: also known as “binary options touch/no touch”, are a bit riskier to trade then the high/low binary options, but the payout is higher. Usually, the Payout for these binary options is around the 100-200% of the capital invested, or even more (around the 300%). These binary options not based on where the asset price is at expiry, but whether an asset price touches a specific level at any time before expiry. With some brokers only one price is given and then you must choose between “Touch” or “No Touch” depending whether you think the asset price will touch the price in question before expiry or not Other brokers offer two prices, and you can choose whether you think the price will touch the upper or lower threshold.
- Binary options range: with these binary options you need to pick whether an asset will finish In or Out of a defined price range. At expiry, the price of the asset must be inside the range to have a winning trade if you selected In. If you selected Out, the asset must be outside the prescribed range at expiry for you to win. The average payout is far above the high/low type, similar to the payout for the one touch binary options.
- Short-term binary options: these are the binary options with the shortest expiry time. In this category falls all the binary options below the 5 minutes expiry times, like the 30 seconds, 60 seconds, 120 seconds and 300 seconds binary options.
How to trade binary options: a practical example
In case you have never traded binary options, let’s see how a trader can place an order on a binary options trading platform. There are five different steps that a trader must do to invest in binary options:
- Choose a type of binary options: in our example, we choose the easiest one to trade, the high/low binary options.
- Choose the asset for the binary option: a trader can choose among shares, stock market indices, forex currency pairs and commodities. Just pick up the one you prefer. Before doing so, remember to analyze the financial chart related to the asset you will choose, to find the current trend (uptrend, downtrend, sideways trend). In our example, we choose the Google’s shares.
- Choose the expiry time: depending on the current trend and your trading strategy, you will have to select an expiry time for your binary option. Expiry times vary from 30 seconds up to 1 week or even one month. The most common expiry times are 15 minutes, 30 minutes, 1 hour and 3 hours. In our example, we select the 1 hour expiry time, because we predict that there will be a rise within the next hour of trading.
- Choose the amount to invest: the capital you invest in a binary option should depend on your money management strategy. Avoid to invest more than the 5% of your total capital for each binary option you trade. We decide to invest $100.
- Select the binary option: depending on your prevision, you will select the right type of binary option. In this case, we have predicted a rise in the value of Google’s shares. Thus, we select the “high” binary option (or “call” binary option). The Payout for our binary option is 85% of the capital invested.
At this point, these are the “settings” we chose for our binary options:
- High/low binary options
- Google’s shares
- 1 hour expiry time
- $100 invested
- Payout = +$185 / Loss = -$100
After one hour, we will know the result of our investment. There are only two possible outcomes:
- Our prediction was right. The value of Google’s shares has increased after one hour. It doesn’t matter how much is changed the value; it only matters that there was a rise in prices. We will earn our Payout equal to $185.
- Our prediction was wrong. The value of Google’s share has decreased after one hour. It doesn’t matter how much is changed the value; it only matters that there was a decrease in prices. We will lose the capital invested in the binary options, aka $100.
External Resources: CFTC FRAUD ADVISORIES > http://www.cftc.gov/ – SEC.GOV > https://www.sec.gov/ (SEC Warns Investors About Binary Options and Charges Cyprus-Based Company with Selling Them Illegally in U.S.) – IN.GOV > http://www.in.gov/sos/securities/4108.htm (Binary Option and Fraud) – METEOFINANZA.COM > http://www.meteofinanza.com/ – EUROPAR2010.ORG > http://www.europar2010.org/ Italian Binary Trading Academy/Course
Conclusion on binary options trading
This simplicity can be misleading, though. You are still trading a financial asset, and as such there are financial risks. While the risk is limited on each trade to the amount you place on the trade, a string of losses can result in a significant loss of capital or the account being cleaned out. That’s why is fundamental to use a well-tested trading strategy for binary options and a proper money management. With binary options, you can nearly double your money quite quickly, with returns sometimes up to 80% or more. But in most cases your risk is always greater as typically you will lose 100% of the dollar amount placed on the trade if you are wrong. Therefore, you must be right more often that you wrong; typically you will need to be right about 55% to 60% of the time to breakeven.