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How to Trade Binary Options

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How To Trade Binary Options | What They Are

Binary OptionsWhile binary options are not particularly new to the world of online trading, they are growing more popular, which has a lot of individual investors wondering what they are and how to trade binary options.  The good news is that binary options trading is one of the easiest trading schemes available in the financial markets and is relatively easy to learn.  Binary options provide only two outcomes, which is why they are called binary.  They either hit their limit price at time of expiration and pay a predetermined amount of money or they fail to reach their limit price at time of expiration and the money used to buy the options is forfeited to the firm that orchestrates trading.  Due to their binary design of either paying the full payout or paying nothing at all, they are known by the moniker “all or nothing options”.

Binary options can be purchased that bet on the price at a specific future time of individual stocks, various exchange traded funds (ETFs), stock market indexes, commodities, and currencies, which depending upon the option could be hours, days, or weeks in the future.  If the financial product that a binary option is based on closes above the target (strike) price upon option expiration, the buyer of the option will be paid a percentage payout that is part of the options purchase agreement.  If it closes below the target price, then the option expires worthless.

Each binary options trading platform (website) has their own specific rules when an option matches the target price upon expiration, with some providing a full refund of the option purchase price and no payout, while others considering it to be an option that failed to exceed the target price and keep the money used to buy the option.  Binary options can be used to bet on either the long and short side of a financial product’s price movement.  Long meaning it is a bet that the underlying financial product will exceed the target price upon option expiration.  Short meaning it is a bet that the underlying financial product will be below the target price upon option expiration.

How Binary Options are Different From Traditional Options

Binary Options Currency
The word “options” is a daunting word for many individual investors, because options are thought of as complicated financial instruments that take a great deal of education to understand and a great deal of research to trade properly.  That is true of traditional options, which often require complicated trades to be set up to trade them effectively and successfully; however that is not the case with binary options.  Binary options trades are not complicated at all.  They are as easy as buying a stock, which is something all individual investors know how to do.

Traditional options allow a stock trader or investor to leverage their stock positions to maximize potential profits or to protect their stock positions by creating a hedge against an unexpected price moves.  While traditional options can be quite useful trading and hedging vehicles, their use is often quite complicated and beyond the understanding or usefulness of the average investor.  Binary options, on the other hand, do not allow leveraging or hedging stock positions, but rather allow a trader to make a simple bet that a stock or other financial product (i.e., ETF, stock index, commodity) will exceed a certain price either to the upside (long) or downside (short) by a specified time and date.

Casino games provide a good analogy to explain the difference between binary options and traditional options.  Sophisticated gamblers can play a casino game such as craps in many different ways using various betting strategies, some which are quite complicated.  The same is true of traditional options.  Whereas, craps also provides a very simple “all or nothing” bet in which a gambler bets the dice thrower will either be successful or will not be successful.  That is exactly how binary options are traded.  Traders place a bet that a financial product, such as a stock, will either be successful or not successful at exceeding a certain level at the time that the binary option expires.

An Example Regarding How Binary Options Are Traded

Put Call  Binary Options

The best way to grasp how binary options are traded is to take a look at an example of a binary options trade.

A trader might buy ten binary cash call options of a biotechnology company’s stock, such as Amgen Inc. (NASDAQ:  AMGN) in anticipation of a positive Food and Drug Administration (FDA) ruling expected the next afternoon.  The trade might cost the trader a total of $500 to buy ten binary cash call options with a strike price of $110 AMGN per share and an expiration at the close of trading the following trading day.  The trader would buy the options with an expectation that AMGN will close above $110 per share after the FDA ruling.

If the FDA ruling is positive and AMGN closes the next day above $110 per share, then the ten binary cash call options will pay the predetermined amount when the trade is executed.  For the purposes of this example, let’s say each of the ten binary cash call options pay $100 when AMGN closes above the $110 target price.  The trader would then collect $1,000 for the ten binary options.  Given the $500 they used to initiate the trade, they will have quickly doubled their money using binary options to bet that AMGN would close above $110 after the FDA ruling.  If AMGN closes below the $110 per share target price, then the ten binary cash call options would expire worthless, and the options buyer would lose the $500 that they spent buying the options.

A Word of Warning Regarding Binary Options Websites

There is no shortage of binary options trading websites that allow traders to trade a wide variety of binary options online.  However, not all of the sites are reputable.  They can be located anywhere in the world and may not be subject to regulatory oversight.  Therefore, it is very important for binary options traders to do their homework and only do business with binary options trading websites that have a good reputation.  Finding one that is located within the country that one lives and is subject to regulatory oversight is a good way to protect oneself from potential problems with using the services of a binary options trading website.

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