A binary option is a financial instrument that will provide a defined risk and clear outcome on every trade. They are based on whether there will be a fixed payoff or no payoff at the end. When entering into a binary options agreement, you will want to determine whether or not the market will be above the price agreed on at the time that the option is exercised. To get a better understanding of binary options and how they work, you will need to know:
- What binary options are and how they work.
- What foreign binary options are and how they differ.
- The types of binary options.
- The risks and rewards of trading binary options.
- Determining the bud and ask.
- Knowing where you can trade binary options.
- The fees associated with binary options.
- Knowing how to pick your binary market.
- Picking the time frame of your binary options.
Binary Options and How do They Work?
Binary options are simple investments, which can make them especially attractive to investors who are just starting out. One of the most popular traded items using this process is a high-low option, which will give investors access to foreign exchanges, commodities, stocks, and indices.
When the options are written, they will have a stated expiration date, a time, and a strike price. In the event that an investor was to guess correctly on the motion of the market’s direction when the option expires, then they will receive the paid fixed retune, no matter how much it had moved during the time frame. If they are incorrect about their guess, then they will lose the initial investment.
Binary options trades will typically buy they call when they suspect bullish activity on a stock, commodity, index, or currency pair. If they feel the market is bearish, they may buy a put. The expiration date, fixed payout, and strike price will all be negotiated when the option is written. The price of binary options will always range between $0 and $100, and there will always be a bid and an ask price.
U.S. Binary Options vs. Foreign Options
When you trade binary options in the U.S. they there will a fixed payout and a set risk from the onset. You are able to buy binary options from brokers directly, but not able to purchase them directly on the exchange. Even though there are some exceptions to the rule, U.S. binary options are typically all or nothing.
Foreign brokers are not allowed to get clients from the U.S. unless they are specifically registered with the Securities and Exchange Commission or the Commodities Futures Trading Commission. Foreign binary options are different from those traded in the U.S. as they are structured differently, so you should proceed with caution when trading with brokers outside of the U.S.
Types of Binary Options
While the most common type of binary option is a high-low binary option, many U.S. brokers will offer several options to their investors such as:
- One-touch options: With these options, the instrument trader will need to touch the strike price before the expiration for a payout to be made.
- Target options: With these options, the buyer will need to pick a target price that the instrument will need to hit before the date and time of expiration.
- Range options: This will allow a trader to pick a price range that the asset will trade within until it expires.
With binary options trading becoming more competitive, more and more brokers are offering products that provide between 50% and 500% payouts to be more attractive to investors,
What are the Risks and Rewards of Binary Options Trading?
As with any form of trading, there are both benefits and risks that come with trading binary options. One benefit of binary options is that you know both the risk and reward when entering into the agreement. There are usually no fees or commissions, and the result will be one of two outcomes. You receive your fixed amount, or you receive nothing. Investors also like binary options as they can choose from a wide range of offered strike prices and expirations, as well as have access to multiple classes of stock.
The main downside to trading in binary options is that with the high-low binary options, the reward is almost always less than the risk. So when using a high-low binary option, the trader must be sure to get a high enough percentage so that you can be sure to cover your losses. Even though payout risks are fairly consistent among brokers and even instruments, you always stand to lose more than you would make winning a trade.
Many investors have found that when they trade binary options in quieter markets, they may fare better than average returns.
How to Determine the Bid and Ask?
The bid and ask will be determined by the investors looking to trade. They will determine this after making an assessment to determine what the probability is that the proposition will be true or not. For example, if you were to request a bid and ask of 75 and 79 on an option, then you are making the assumption that the outcome of the binary will likely result in a less.
In the event you were to have a bid and an ask of 10 and 15, then it is a high likelihood that the option outcome may be no and will end up expiring at $0. In this instance, the buyer is looking to take a small risk to obtain a bigger gain. The seller will be looking to make a small but more likely profit, but it will come with a larger risk.
Where Can You Trade Binary Options?
The first legal exchange of binary options was on the Nadex exchange, and it is still the most popular place for trading binary options. They provide their traders with their own browser-based binary options trading platform, which allows traders to be able to use a demo account to practice before switching to a live account. The platform also includes real-time charts with direct market access to binary price options.
You can also trade options through the Chicago Board Options Exchange, which allows anyone with an options-approved brokerage account.
What Are the Fees for Trading Binary Options?
When trading on the Nadex, it will cost $0.90 to enter into the option and $0.90 to exit. The fees are capped when they reach $9, so even if you purchase 20 lots, it will still only cost you $9 to enter and $9 to exit. When you hold the trade until it is finalized and finish in the money, the exit fee will be assessed and paid at the expiration of your option. In the event that you hold the trade until the settlement time, but are out of money, there will be no fee accessed in your exit. When you trade binary options through a brokerage, you will be subject to whatever brokerage fees that thy decide to charge.
Picking Your Binary Market
You can trade multiple asset classes when trading in binary options. When you trade on the Nadex, you will have the ability to trade in some of the major indices including:
You can also trade in indices for the United Kingdom include:
You also can trade on Forex pairs including:
The NADEX will also binary options on commodities that are related to such things as:
- Crude oil
- Natural gas
You can also trade binary options on events. These options can include:
- Whether or not the Federal Reserve will raise or lower rates
- Whether job claims and nonfarm payrolls will be above or below the consensus estimates
Binary options can also be traded on the CBOE, but they only include two options:
- S&P 500 Index
- Volatility Index Option
How to Pick the Time Frame of Your Option
When you choose to trade binary options on the Nadex, you can choose from asset classes that can expire:
- Hourly: Hourly options are usually used for day traders, under more calm market conditions. This is done to gain a return by choosing the right direction in which the market is going in a certain amount of time.
- Daily: These options will expire at the end of the trading day and are often used by day traders who are trying to hedge other company holdings, stocks, or forex, against the movements of the day.
- Weekly: A weekly binary option will expire at the conclusion of the trading week and is most commonly used by swing traders or day traders.
- Event-based: When the option is based on an event, the options will expire once the official news release about the event comes out. All range of traders will get a position in advance of and up to the expiration.
Trading in binary options is a simple way to trade options that is appealing to all types of investors because the risk is known upfront. Want to learn more about how to get into binary options trading? Learn more from our free e-book or sign up for one of our webinars.