Binary Option Assets Explained

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A Guide to Trading Binary Options in the U.S.

Binary options are financial options that come with one of two payoff options: a fixed amount or nothing at all. That’s why they’re called binary options—because there is no other settlement possible. The premise behind a binary option is a simple yes or no proposition: Will an underlying asset be above a certain price at a certain time?

Traders place trades based on whether they believe the answer is yes or no, making it one of the simplest financial assets to trade. This simplicity has resulted in broad appeal among traders and newcomers to the financial markets. As simple as it may seem, traders should fully understand how binary options work, what markets and time frames they can trade with binary options, advantages, and disadvantages of these products, and which companies are legally authorized to provide binary options to U.S. residents.

Binary options traded outside the U.S. are typically structured differently than binaries available on U.S. exchanges. When considering speculating or hedging, binary options are an alternative—but only if the trader fully understands the two potential outcomes of these exotic options.

Now that you know some of the basics, read on to find out more about binary options, how they operate, and how you can trade them in the United States.

U.S. Binary Options Explained

Binary options provide a way to trade markets with capped risk and capped profit potential, based on a yes or no proposition.

Let’s take the following question as an example: Will the price of gold be above $1,250 at 1:30 p.m. today?

If you believe it will be, you buy the binary option. If you think gold will be below $1,250 at 1:30 p.m., then you sell this binary option. The price of a binary option is always between $0 and $100, and just like other financial markets, there is a bid and ask price.

The above binary may be trading at $42.50 (bid) and $44.50 (offer) at 1 p.m. If you buy the binary option right then, you will pay $44.50. If you decide to sell right then, you’ll sell at $42.50.

Let’s assume you decide to buy at $44.50. If at 1:30 p.m. the price of gold is above $1,250, your option expires and it becomes worth $100. You make a profit of $100—$44.50 = $55.50 (minus fees). This is called being in the money. But if the price of gold is below $1,250 at 1:30 p.m., the option expires at $0. Therefore you lose the $44.50 invested. This called out of the money.

The bid and offer fluctuate until the option expires. You can close your position at any time before expiry to lock in a profit or a reduce a loss, compared to letting it expire out of the money.

A Zero-Sum Game

Eventually, every option settles at $100 or $0—$100 if the binary option proposition is true and $0 if it turns out to be false. Thus, each binary option has a total value potential of $100, and it is a zero-sum game—what you make, someone else loses, and what you lose, someone else makes.

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Each trader must put up the capital for their side of the trade. In the examples above, you purchased an option at $44.50, and someone sold you that option. Your maximum risk is $44.50 if the option settles at $0, and so the trade costs you $44.50. The person who sold to you has a maximum risk of $55.50 if the option settles at $100—$100 – $44.50 = $55.50.

A trader may purchase multiple contracts if desired. Here’s another example:

  • NASDAQ US Tech 100 index > $3,784 (11 a.m.).

The current bid and offer are $74.00 and $80.00, respectively. If you think the index will be above $3,784 at 11 a.m., you buy the binary option at $80, or place a bid at a lower price and hope someone sells to you at that price. If you think the index will be below $3,784 at that time, you sell at $74.00, or place an offer above that price and hope someone buys it from you.

You decide to sell at $74.00, believing the index is going to fall below $3,784 (called the strike price) by 11 a.m. And if you really like the trade, you can sell (or buy) multiple contracts.

Figure 1 shows a trade to sell five contracts (size) at $74.00. The Nadex platform automatically calculates your maximum loss and gain when you create an order, called a ticket.

Nadex Trade Ticket with Max Profit and Max Loss (Figure 1)

Binary Option Assets Explained | A Comprehensive Guideline

Binary options are a unique financial trading product where investors can either receive a payout or lose once the option has expired. Since the nature of trading is based on the movement of various assets, you do not buy any of the assets. Instead, you only trade on changes in the assets.

There is a wide range of financial assets that you can trade, depending on your familiarity with the asset. But as different as the assets are from each other, they also offer different levels of risk.

Some are quite volatile, while others come with much lower risks. Hence, investors who have more experience also have an idea of exactly how each of the assets performs at certain times.

Here is a better explanation of some of the most popular Binary Options Assets.

1.Forex Exchange

Commonly known as Forex (FX) it involves trading in currencies. It’s based on values in currency pairs and how they rate against each other. One is usually the base, and the other is quote currency. Just a few of them are considered as major currencies. These are the USD, Pound, Euro, AUD (Australian dollar, and JPY (Japanese Yen).

These currencies are known to have a major significance on the world market interest rates. Some of the considerations of the value of a currency depend on the economic performance and interest rates of the country of the currencies under exchange.

Thus, trading in currency pairs requires you to predict which currency outperforms the other in the pair. The best way to succeed in this type of asset is to conduct proper fundamental analysis so that you can make better predictions.

2.Stock Trading

To raise capital, companies usually issue shares of their enterprises. Now, each stock also represents a share and the more powerful and performing a company is, the more its shares go up in value.

The reason why most investors prefer trading stocks under binary options is because of the less risk they carry, as opposed to alternatives like day trading. Therefore, as a trader, all you need to do is bet on the amount you are willing to lose based on the predictions, and you do not have to buy the stocks at all.

Trading in stocks requires you to have an understanding of the prevailing market trends so that you can make the right choice of stocks. Some of the popular stocks on the market right now include Apple Inc., Vodafone, and Barclays PLC, among others.

3.Commodities Trading

These are natural products of high value and which include gold, silver, wheat, cotton, and oil. Commodities remain a popular choice of investors because most of them come with lower risks. They are known to exhibit much lower volatility, compared to other assets.

However, their level of fluctuation also depends on the prevailing political and economic environment of the countries of origin of each commodity. For example, energy products can easily be influenced not just by political contexts at home, but also the overall state of the economy.

This can affect the demand and supply factors. Also, for a long time, weather patterns have been known to affect not just agriculture-based commodities but also gas.

In the meantime, such a commodity as oil is usually considered as a safe type of investment which comes with more stability due to demand. It’s one of the assets in the commodity category that performs well, even when the other markets are uncertain. For this reason, most traders who opt for commodities usually sway towards oil as a safety net.

Pricy metals such as gold and silver are also much safer as they are considered to be stores of value. Their prices can easily withstand any kinds of uncertainties; such as economic and political doldrums as compared to other assets. A wise trader can diversify their trading assets include commodities as a way of minimizing risks, and creating a buffer against any substantial losses.

4.Indices Trading

Indices take into consideration an overall group of stocks, instead of individual stocks. This works better because you can diversify more since you are spreading your investment over a more significant number of shares. Another good thing with indices is that if one of the stocks happens to fluctuate, you can rely on other stocks in the index to counterbalance the risks.

It’s quite rare that all stocks face the same fate at the same time. So, this type of asset can easily shield you, in the event of any one of them performing below par. Some of the very popular indexes on the market include NASDAQ, Daw Jones, and FTSE 100.

If you choose to trade on NASDAQ, you need to predict whether those NASDAQ-based companies’ stocks are going up or down. Indices generally represent the performance of a financial market and how it behaves in moments of volatility. Since these indices are based on companies in the same industry, you can easily do your analysis to determine the market trends.

Because of their nature, they also represent a minimal risk, as the peaks and drops are less noticeable. Again, when you compare with commodities, they are not easily affected by political and environmental factors. This allows investors to opt for them as a way of diversifying risks. Indices work exceptionally well for those investors who have experienced. This is because they already have an idea of how specific industries and the market behave at certain times.

Conclusion

The expansive range of binary options assets means that traders have several choices at their disposal, which can help in risk diversification. The knowledge of each of these assets also gives you a good overview of the type of asset that you trade.

Some are quite volatile, while others are not as much. For example, oil is a commodity that is known for consistency, but it can also jump depending on just about any arising factors.

To make that right move, you have to be on the lookout for changes in value. Other than that, most of the assets require you to conduct a proper analysis to make the right predictions.

Binary Option

What is a Binary Option?

A binary option is a financial product where the buyer receives a payout or loses their investment, based on if the option expires in the money. Binary options depend on the outcome of a “yes or no” proposition, hence the name “binary.” Binary options have an expiry date and/or time. At the time of expiry, the price of the underlying asset must be on the correct side of the strike price (based on the trade taken) for the trader to make a profit.

A binary option automatically exercises, meaning the gain or loss on the trade is automatically credited or debited to the trader’s account when the option expires.

Binary Options Outside the US

Basics of a Binary Option

A binary option may be as simple as whether the share price of ABC will be above $25 on April 22, 2020, at 10:45 a.m. The trader makes a decision, either yes (it will be higher) or no (it will be lower).

Let’s say the trader thinks the price will be trading above $25, on that date and time, and is willing to bet $100 on it. If ABC shares trade above $25 at that date and time, the trader receives a payout per the terms agreed. For example, if the payout was 70%, the binary broker credits the trader’s account with $70.

If the price trades below $25 at that date and time, the trader was wrong and loses their $100 investment in the trade.

Key Takeaways

  • Binary options depend on the outcome of a “yes or no” proposition.
  • Traders receive a payout if the binary option expires in the money and incur a loss if it expires out of the money.
  • Binary options set a fixed payout and loss amount.
  • Binary options don’t allow traders to take a position in the underlying security.
  • Most binary options trading occurs outside the United States.

Difference Between Binary and Vanilla Options

A vanilla American option gives the holder the right to buy or sell an underlying asset at a specified price before the expiration date of the option. A European option is the same, except traders can only exercise that right on the expiration date. Vanilla options, or just “options,” provide the buyer with potential ownership of the underlying asset. When buying these options, traders have fixed risk, but profits vary depending on how far the price of the underlying asset moves.

Binary options differ in that they don’t provide the possibility of taking a position in the underlying asset. Binary options typically specify a fixed maximum payout, while maximum risk is limited to the amount invested in the option. Movement in the underlying asset doesn’t affect the payout received or loss incurred.

The profit or loss depends on whether the price of the underlying is on the correct side of the strike price. Some binary options can be closed before expiration, although this typically reduces the payout received (if the option is in the money).

Binary Options and Regulation

Binary options occasionally trade on platforms regulated by the Securities and Exchange Commission (SEC) and other regulatory agencies, but most binary options trading occurs outside the United States and may not be regulated. Unregulated binary options brokers don’t have to meet a particular standard; therefore, investors should be wary of the potential for fraud. Conversely, vanilla options trade on regulated U.S. exchanges and are subject to greater oversight.

Real World Binary Options Example

Nadex is a regulated binary options exchange in the United States. Nadex binary options are based on a “yes or no” proposition and allow traders to exit before expiry. The binary option’s entry price indicates the potential profit or loss, with all options expiring worth $100 or $0.

Let’s assume stock Colgate-Palmolive Co. (CL) is currently trading at $64.75. A binary option has a strike price of $65 and expires tomorrow at 12 p.m. The trader can buy the option for $40. If the price of the stock finishes above $65, the option expires in the money and is worth $100. The trader makes $60 ($100 – $40).

If the option expires and the price of the Colgate is below $65 (out of the money), the trader loses the $40 they put into the option. The potential profit and loss, combined, always equals $100 with a Nadex binary option.

If the trader wanted to make a more significant investment, he or she could change the number of options traded. For example, selecting three contracts, in this case, would up the risk to $120, and increase the profit potential to $180.

Non-Nadex binary options are similar, except they typically aren’t regulated in the United States, often can’t be exited before expiry, usually have fixed percentage payout for wins (whereas Nadex payouts fluctuate based on the price paid for the option) and may not trade in $100 increments.

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