What are Binary Options?
What are binary options? Binary options are also called digital options or fixed return options. Binary options are based on the all or none principle, which means that it is either the trader gets all the profits that can be possibly obtained in a trade, or the trader loses all that can be lost in the trade. This is very different from a forex trade for example, where a trader who has set a profit target can decide to claim some of the profits before hand by manually closing the position, or can decide to reduce losses by closing the position manually before the stop loss target he has set is reached.
Binary options are relatively new, having only been around for the retail investment market for four years. Trade outcomes in the binary options market are not simply a matter of going long or short on a asset, but will depend on being able to interpret a wide range of behaviour that the asset can assume. For instance, if a trader trades a boundary options contract, and chooses the OUT option, he can gain from the trade whether the asset is rising or falling, in so far as the asset is able to touch any of the price boundaries. In the forex market, you can only win if the asset moves in your chosen direction. These are some of the little nuances that the market presents.
Binary options contracts have some features which are unique to the digital options market:
1) Trades in the binary options market do not last forever. Unlike the forex market where a position can be left open for the whole year, binary options trades have a time limit. The maximum time limit for a binary options trade is 3 months. However, there are platforms that allow traders to set trades to last for as low as 30 seconds. There are also platforms that allow traders to choose how long they want trades to last, while some others can only allow traders to choose from default settings that have been applied to the trading platform.
2) As has been stated earlier, the outcomes of binary options trades follow an “all or none” pattern. You either win it all or lose it al. Even though there are brokers now that allow traders to close out positions before the set expiry time, the fundamental principle of all or none still exists on many trading platforms.
3) In the binary options market, any trading losses incurred are limited to whatever the trader has invested in the trade. In other markets, trades that are not protected with stops have no limit as to the damage that they can cause accounts as losses are unrestrained.
4) Traders can get the information as to how much they can expect to win or lose in a trade, even before they commit to the trade. This helps binary options traders weigh the risk against the rewards of their trades. In other markets, such responsibility is conferred strictly on the trader; the broker’s platforms do not give any such risk assessment information.
Types of Binary Options Trades
It has already been stated earlier in this piece that winning a binary options trade is not merely a matter of going long or short in a financial asset, but is a function of understanding the different contracts which are used to define or measure the behaviours of the traded assets in the market. Based on this information, several trade types have been designed to test the trader’s analytical ability, and raise the standard when it comes to being able to make money in the binary options market. Some of these trade types are as follows:
1) High/Low: This is a trade contract that is designed according to the traditional long/short orders in the forex and commodity markets. They are also designated as the Up/Down, Call/Put or Above/Below binary options, depending on the trading platform used. The beauty of this trade type is that unlike the long/short order types in forex where the winnings are determined by the number of pips and the trade volume, winning the High/Low trade can be determined by one single pip in the trader’s direction.
2) In/Out: This is also called the range trade, boundary trade or “trading the tunnel”. The outcome of this trade is determined by the price remaining range-bound or breaking out of the defined range of prices or price boundaries. The forex or commodity markets do not pay money for assets that are in a tight range, but the binary options market can pay the trader for such an outcome. Amazing isn’t it? A trading platform brand also has a variation of this trade known as the High Yield Boundary, where an OUT outcome can pay the trader 400% gain.
3) Touch/No Touch: A trader can look at the price action of an asset and decide that rising or falling prices will either touch a particular price, or not touch it at all. SpotOption’s trading platform will even reward a trader for an ambitious TOUCH trade to the tune of 500%. Touch or not to touch is the question that this trade contract answers.
Trade Example
Andy trades a binary options contract on the EURUSD, predicting that the price will be higher than market price in 24 hours. He decides to select UP. He immediately sees his trade tank, and the price consistently stays below the entry price for 23 hours and 50 mins. With two minutes to go, a news report is released which is USD negative and his trade closes at the same price at which he entered the trade. Did he win or lose in this trade?
Answer: This trade is one of the few instances where a High/Low trade can end at breakeven point. In this trade, the trader neither wins nor loses, and he can then set his sights on taking another profitable trade.
If you want to get on top of binary options then have a browse of our strategy section.