NO18 - What Are Binary Options?

"The search for speculation is quite high when it comes to the financial markets. Regardless of what fancy term you give it, at the end of the day, the investor or the day trader is merely speculating on the price. When they are right, the investor or the day trader is rewarded. And there is the risk factor as well. Among the different products available, binary options are something new. But at the same time, they primarily designed as a pure speculative play. If you want to bet on the direction of the markets, then binary options allow you to do so with a fixed amount of risk. But there are significant risks to trading binary options. In this article, we give you a primer on what binary options trading is all about and how these products work. As a beginner to forex trading it is important to understand the different financial products that you will come across."

If you have been reading about retail forex trading, chances are that you might have come across binary options. Binary options work slightly different to how regular option contracts work. In some cases, you might come across articles that try to convince you that binary options are a great way to hedge your risks.

This entirely depends on the binary option contract that you are trading. In any case, binary options that you see in the retail community are very different to how traditional options contracts are created. For the most part, binary options are used as a speculative tool rather than as a hedge.

We should inform you upfront that binary options trading is risky. In fact it has become so risky that many regulators around the world have clamped down on binary options trading. In some countries in the European Union, it is illegal to trade binary options. This goes to show the level of risk that comes with binary options.

But having said that, binary options trading is not that difficult.

Binary options are simply option contracts with a binary outcome. This is where the name comes from. You are either in the money or out of the money. To explain how binary options contracts work, let’s take an example.

Let’s say that the EURUSD currency pair is trading at 1.1200. You expect the price of the euro rise over the next three days. Therefore, using binary options, you can purchase a CALL option.

Depending on the binary options broker that you trade with, you will receive a fixed percentage of the amount that you invested into that binary options contract.

So, going back to the example you will purchase a PUT option in EURUSD with a three day expiry time. You have invested $100 into this PUT option that you purchased. When the contract expires, the current spot rate is compared to the rate at which you bought the option.

If your analysis proved to be correct and indeed the EURUSD was trading higher than the $1.1200 level, you will get, let’s say 50%, thus giving you a profit of $50.

Similarly, if you think that the price of the EURUSD will fall from the current value of 1.1200 in the next day, then you will purchase a one-day expiry on the EURUSD which is nothing but a PUT option.

If the price of the EURUSD does indeed fall below this level, you will again make a profit.

Difference between binary option and traditional options?

One of the reasons why binary options are banned in many countries is because, traders think that they are similar to regular options. This is not true. In case you were buying a regular options contract, you would pay a premium.

Furthermore, if you are the buyer of the contract and if you wanted to exercise the contract, you would get the delivery of the underlying security. With binary options, this is not the case.

There are no premiums to pay initially when you enter the contract. The amount you invest in the contract, in a way becomes the premium you pay.

Secondly, if your binary options contract ended in the money, then you would only get a percentage payout of the contract. This means, that the contract is settled in cash and there is no delivery of the underlying contract even if you want to exercise your right.

Binary options are pure speculation products where the trader can speculate on the direction of the instrument during a specified period of time. The amount you invest into the contract is often called the invested or the risk amount.

The payout can vary from one broker to another. Some pay about 50% while others can go much higher. Even within binary options, there are other exotic options such as one-touch, no-touch and so on.

But as the product rightfully says, your risk is limited to just the amount you invest into the binary options contract. But if you look at the risk/reward ratio, you will never be able to achieve a 1:1 risk/reward ratio.

This is because the payout is often limited to just under 85%. Meaning that with every binary options contract you end up risking more than what you can win. This goes in contrary to the general lines of investing where you invest money in order to double or triple the rewards based on the amount that you risked.

Just as with regular options, there are binary options on various products from currencies, to stocks to indices and commodities.

Read 916 times Last modified on Sunday, 12 May 2019 07:59