Introduction to Binary Options
Binary options are also referred to as all-or-nothing options, since it is a type of option where the payoff is all or nothing. The return is therefore fixed and it comes to no surprise that such options are also known as: FRO's-Fixed Return Options. Digital options is also another commonly used term. More simply a trader just needs to make a decision about the direction of a rate change: whether the underlying asset's price is going up or going down without taking other factors into consideration.
Binary Options trading is considered as one of the fastest growing segments of the simplified trading products.
Binary options are fixed-odds-return investment products that have two possible absolute outcomes with structured reward and risk, hence the word 'binary'.
Binaries are considered as a mass market financial instrument as it empowers traders with a very flexible trading approach without the complexities involved in trading traditional vanilla options.
Whether you are looking for a short term speculation or hedging your portfolio, binaries can help you get a high payout within short trading durations as so, binaries are gaining popularity among traders globally.
Binary contracts are available on a variety of underlying assets: Stocks, Commodities, Currencies and Indices.
When the expiry level is equal to the strike price the contract will expire at the money. Normally, there will be a fixed cash settlement to be returned which is often the initial investment, however this depends on what was predetermined and agreed in the contract.
For example: Google price is now 430.25$ and you want to speculate on the price movement of the share within a time frame of 1 hour.
If you think that Google will fall below this price level, than you should buy a binary put option- if Google price will be below the current price level during expiry than the option will expire in the money, paying you the fixed odds return promised during the trade. If not, the option will expire out of the money.
Difference between Binary and vanilla options
Binary Options Vs Traditional Options Comparison
Vanilla Options Vs. Binary Options
Traditional Options: Once a month.
Binary Options: Variety of expiration terms: end of day, hourly and Even shorter expiration like 15 min binaries.
Traditional Options: Dynamic, based of the underlying asset price.
Binary Options: Fixed.
Traditional Options: Requires a relation of the strike price of an option and the underlying price in order to execute the option.
Binary Options: Price movement isn't relevant, just the direction (above or below).
Traditional Options: Options usually can be exercised any time prior to expiry.
Binary Options: Can't be exercised before expiry.
Right to buy:
Traditional Options: The option owner has the right to exercise his options and turn them into stocks in case option expires 'In-the-money'.Binary Options: Don't have the right to exercise to stocks.
Advantages of Binary Options
Simplicity-Whether the instrument will close above or below?
• The trader only needs to consider the direction of the asset price.
Limited risk and predetermined payout
• The payoff of a binary option contract is fixed and pre-determined so therefore the potential risk and reward is known from the outset. Whereas with traditional options there are no outlined parameters so the possible loss or gain is not known.
• The binary option will settle the contract irrespective of how much the asset price is 'In the money' at expiration. Therefore even if the contract is only successful by one tick the contract still pays out at the fixed level.
• Simplified hedging your portfolio
• As opposed to vanilla options, While trading binary options the options can close 'in the money 'collecting the full payoff even with a minimal price change of a single tick.
• Binary options are issued 24/7, allowing traders to trade on multiple time frames. As binaries are on a variety of global underlying assets from different exchanges traders are now able to trade binary options 24/7 under the same binary options platform.
Binary Options Trading Strategies
Often binary options' traders will open positions related to events that historically have a big influence on market prices. Fox example quarterly profit or loss announcements from firms are eagerly watched by potential traders and betters, since positive or negative results often reflect the movement of the share prices. As well as formal preplanned announcements traders will always be watching the news, as many different events can influence the markets i.e. Natural disasters to political changes. Eventually the best strategies come with experience which cant be taught.
Binary Options in Global Financial Markets
Binary options falls under the umbrella of exotic options but within financial market they are often referred to as digital options.
Digital options are usually traded OTC (over the counter) across all assets in financial markets but more commonly used within the Forex and Interest markets. More recently numerous stock exchanges have produced listed digital options on selected stocks, commonly known as FRO fixed return options. Today the CBOE offers fixed return options on S&P500 and VIX, also 20 stocks were listed on the AMEX in 2008.