Binary Options
The term Binary means the option pays a set dollar amount at expiration if the option is above the strike price or the option pays nothing if the option is below the strike price. Binary options do not allow traders to take a position in the underlying asset. Only if the strike price is In The Money then the trader would receive the fixed amount but if the strike price is Out Of The Money or At The Money the trader will receive nothing.
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It is a fixed option where the payoff is a fixed amount or you receive nothing. The trader receives a payout if the options expire In The Money and incur a loss if the option expires Out Of The Money or At The Money. No matter which Binary Option you trade ‘Position Size’ is important. Binary Options are traded only outside the U.S.
Types of Binary Options:
There are two types of Binary Options:
- Cash-or-nothing call (put) – A Fixed amount is paid if the asset ends up above (below) the strike price. Otherwise, no payment is made.
- Asset-or-nothing call(put) – It puts the value of the stock if the stock price ends up above (below) the strike price at expiration. Otherwise, no payment is made.
How does Binary Option work?
A binary option depends on the outcome of the ‘yes’ or ‘no’ proposition. For example, if there is a share of $100 and the trader has to make a decision of yes or no that whether the price will increase or decrease above $25. If the trader makes a decision that the strike price will increase and if it increases the trader will receive a payout as per the agreed terms, for example, the payout is 60% the trader receives $60 (100 x 60% = $60). But if the price does not rise then the trader will face a loss of $100.
Example:
Nadex is a regulated Binary Options exchange in the U.S. The binary option indicates a potential profit of $200 or $0. Let’s assume the stock is currently trading at $124 and the binary options strike price is $125. The trader can buy the option at $100. If the price of the stock goes above $125 that means the option expires in the money and so the trader will make a profit of $25 ($125-$100). But if the option expires and the price of the stock is below $125, the trader loses the $100 put into the option.
How Can A Trader Use Binary Option?
Using a Binary Trade is very easy and these are the steps that can be used for trading in Binary Options.
- Choose a broker
- Select the asset or market to trade-in
- Select the expiry time
- Set the size of the trade you want to trade-in
- Select whether to trade in call or put
- Check and confirm the trade
A trader should also know about the market trends before trading in binary Options and should be very clear about the market to trade in. the strike price and expiration should be correctly selected. If the trader wants to make a more significant investment the trader can change the number of options traded.
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Risks with Binary Option:
Binary options are options where you make a fixed amount of profit or nothing. The fixed amount of profit is based on the increase or decrease in strike price (depending on what you pick). If the ‘yes’ or ‘no’ proposition goes wrong then the amount invested is a loss. Binary option has a maximum risk which is fixed and with this, the trader already knows in advance the amount which the trader is going to lose if it is a loss.
Final Thoughts:
Binary options are a great way of earning income. The trader should just make the right decision of a yes or no proposition. There is a fixed income if the decision is correct or else there can also be a loss. The trader already knows about the maximum risk as it is fixed. If the trader wants to make a more significant investment the trader can change the number of options traded. No matter which Binary Option the trader trades in the ‘Position Size’ is important.
Author – Saachi Lodha
About the Author – A passionate professional with knowledge of Accounting and Finance and currently exploring Financial Risk Management (FRM) to gain knowledge and exposure. As a part of the FRM course also writing blogs to explore the field more and deep dive into the content.
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