How Binary Options Trading Works

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What are binary options and how do they work?

Being a relatively new form of financial trading, understanding what binary options are is imperative to build a successful trading career. Compared to other forms of financial trading such as Forex and Stock trading, understanding how binary options work is fairly easy. Today, we have created an article on binary options specifically custom made for beginners. Having said that, if you are already trading binary options, feel free to check out our other articles on binary options as well as our unbiased broker and software reviews.

What are Binary Options?

Binary options are trading contracts where the buyer has the right but not the obligation to exercise an option. Binary options are usually referred to as all or nothing trading contracts. Basically, by entering into a contract with a binary options broker, you can either lose the entire investment or win a handsome payout. However, if you are lucky enough, some brokers may offer a refund in the event of a lost trade. Even though binary options were incepted in 2008, they have been in existence for a very long time. Initially, they were mainly traded over-the-counter and were reserved for the elite members of the society and institutions such as banks. As of today, anyone can trade binary options, anytime and from anywhere.

What you need to trade binary options

On the onset of a trading career, you will need to find a broker to be able to access a trading account and a trading platform. With access to a trading platform, you can trade financial securities with the options provided by the broker.

Unlike in stock trading where a trader is required to have a sizable investment before delving into trading, you can start trading options with as low as $1(You heard me right!).However, the starting capital is always hinged on the binary options broker chosen. You will also need a stable internet connection since modern options are traded online; either by use of desktop web applications or mobile devices. And again, it all boils down to your broker.

How binary options work

As mentioned earlier, learning the ropes in binary options trading is a piece of cake. This is mainly because it involves predicting the direction of price movements of the underlying assets. You are only supposed to predict if the price of the selected asset is more likely to rise or fall in preset time frames known as expiry durations. If you predict the market price to fall, you buy the PUT option and CALL option if you anticipate the price to rise. As simple as that!

The outcome of a binary options trade is determined by comparison of the expiry price (price of an asset at the lapse of a trading duration) and the Starting price. If for instance, you predicted a decline in the market price the expiry price should be lower than the price at the start of the trade. The same applies if you predicted a positive change in the market price of the asset; the expiry price should be higher than the starting price.

A binary options trade can have two outcomes. A trader can either lose or win a trade. A trade is said to end out of the money if the initial prediction does not come to fruition. In simpler terms, a trade has an out of the money outcome when the market moves against your initial predictions. In case of an out of the money outcome, you lose the invested funds either wholly or partially depending on a broker. A trade is said to end in the money when your initial predictions materialize at the expiry of a trading contract. An out of the money outcome attracts a sizable payout as agreed with the broker at the start of a trade. Payouts usually range between 60-90% for standard trades and they can sometimes be as high as 1000% for high-risk trades. In some instances, although they are rare, the market price of the asset can remain constant and such trade is said to end at the money. In case of an at the money outcome, the broker refunds the invested capital and hence a trader makes zero profits or losses. Interestingly, the magnitude of price change does not affect an outcome of a trade. Even if the price of an asset change by 0.001 to favor your predictions, rest assured you will win the trade.

Types of binary options

Apart from the classic Call and Put options, there are more options offered by binary options brokers. However, it is worth noting that the numbers of options offered vary from one broker to another. Meaning, you can find one broker offering an option but lack the same option on another broker’s platform. One of the options offered by binary options brokers is the High/Low option which is strikingly similar to Call/Put. With range options, a trader is required to predict whether the market price of the underlying asset will be within a given range of limits at the expiry of a trading contract (my favorite).Touch and No Touch options, on the other hand, require a trader to predict whether the price of an asset will hit or not hit a set target price. Binary options brokers may also offer option builder option. With this option, a trader can customize his/her own option with preferred settings. An option created by option builder has to be accepted by a broker before it goes live.

Is Trading Binary Options Easy?

Trading binary options are very simple (theoretically!) but do not let the simplicity fool you. There is more to trading binary options successfully other than predicting the direction of price movements. The truth is, binary options trading is like any other financial trading market with a substantial amount of risks. Therefore, as a beginner, you should take your time when choosing a broker and use a demo trading platform (if provided) to learn the ropes before using a live trading platform.

What You Need To Know About Binary Options Outside the U.S

What Do You Need To Know About Binary Options Outside the U.S?

Binary options let traders profit from price fluctuations in multiple global markets, but it’s important to understand the risks and rewards of these controversial and often-misunderstood financial instruments. Binary options bear little resemblance to traditional options, featuring different payouts, fees, and risks, as well as a unique liquidity structure and investment process.

Binary options traded outside the U.S. are also structured differently than those available on U.S. exchanges. They offer a viable alternative when speculating or hedging but only if the trader fully understands the two potential and opposing outcomes.

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  • Binomo
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The Financial Industry Regulatory Authority (FINRA) summed up regulator skepticism about these exotic instruments, advising investors “to be particularly wary of non-U.S. companies that offer binary options trading platforms. These include trading applications with names that often imply an easy path to riches.” 

Key Takeaways

  • Binary options have a clear expiration date, time, and strike price.
  • Traders profit from price fluctuations in multiple global markets using binary options, though those traded outside the U.S. are structured differently than those available on U.S. exchanges.
  • Non-U.S. binary options typically have a fixed payout and risk, and are offered by individual brokers rather than directly on an exchange.
  • While typical high-low binary options are the most common type of binary option, international brokers typically offer several other types of binaries as well.

Binary options outside the U.S. are an alternative for speculating or hedging but come with advantages and disadvantages. The positives include a known risk and reward, no commissions, innumerable strike prices, and expiry dates. Negatives include non-ownership of the traded asset, little regulatory oversight, and a winning payout that is usually less than the loss on losing trades.

Understanding Binary Options Outside the U.S

What Are Binary Options?

Binary options are deceptively simple to understand, making them a popular choice for low-skilled traders. The most commonly traded instrument is a high-low or fixed-return option that provides access to stocks, indices, commodities, and foreign exchange.

These options have a clearly stated expiration date, time, and strike price. If a trader wagers correctly on the market’s direction and price at the time of expiration, they are paid a fixed return regardless of how much the instrument has moved since the transaction, while an incorrect wager loses the original investment.

The binary options trader buys a call when bullish on a stock, index, commodity, or currency pair, or a put on those instruments when bearish. For a call to make money, the market must trade above the strike price at the expiration time. For a put to make money, the market must trade below the strike price at the expiration time.

The broker discloses the strike price, expiration date, payout, and risk when the trade is first established. For most high-low binary options traded outside the U.S., the strike price is the current price or rate of the underlying financial product. Therefore, the trader is wagering whether the price on the expiration date will be higher or lower than the current price.

Binary Options Outside the US

Foreign Versus U.S. Binary Options

Non-U.S. binary options typically have a fixed payout and risk and are offered by individual brokers rather than directly on an exchange. These brokers profit from the difference between what they pay out on winning trades and what they collect on losing trades. While there are exceptions, these instruments are supposed to be held until expiration in an “all-or-nothing” payout structure.

Foreign brokers are not legally allowed to solicit U.S. residents unless registered with a U.S. regulatory body such as the Securities and Exchange Commission (SEC) or Commodities Futures Trading Commission (CFTC).

The Chicago Board Options Exchange (CBOE) began listing binary options for U.S. residents in 2008.   The SEC regulates the CBOE, which offers investors increased protection compared to over-the-counter markets. Chicago-based Nadex also runs a binary options exchange for U.S. residents, subject to oversight by the CFTC.

These options can be traded at any time, with the rate fluctuating between one and 100, based on the current probability of the position finishing in or out of the money. There is full transparency at all times and the trader can take the profit or loss they see on their screen prior to expiration.

They can also enter as the rate fluctuates, taking advantage of varying risk-to-reward scenarios, or hold until expiration and close the position with the maximum gain or loss documented at the time of entry. Each trade requires a willing buyer and seller because U.S. binary options trade through an exchange, which makes money through a fee that matches counter-parties.

High-Low Binary Option Example

Your analysis indicates the Standard & Poor’s 500 index will rally for the rest of the trading day and you to buy an index call option. It’s currently trading at 1,800 so you’re wagering the index’s price at expiration will be above that number. Since binary options are available for many time frames—from minutes to months away—you choose an expiration time or date that supports your analysis.

You choose an option that expires in 30 minutes, paying out 70% plus your original stake if the S&P 500 is above 1,800 at that time or you lose the entire stake if the S&P 500 is below 1,800. Minimum and maximum investments vary from broker to broker.

Say you invest $100 in the call that expires in 30 minutes. The S&P 500 price at expiration determines whether you make or lose money. The price at expiration may be the last quoted price, or the (bid + ask)/2. Each binary options broker outlines their own expiration price rules.

In this case, assume the last quote on the S&P 500 before expiration was 1,802. Therefore, you make a $70 profit (or 70% of $100) and maintain your original $100 investment. If the price finished below 1,800, you would lose your original $100 investment.

If the price expires exactly on the strike price, it is common for the trader to receive her/his money back with no profit or loss, although brokers may have different rules. The profit and/or original investment is automatically added to the trader’s account when the position is closed.

Other Types of Binary Options

The example above is for a typical high-low binary option—the most common type of binary option—outside the U.S. International brokers will typically offer several other types of binaries as well.

These include “one-touch” options, where the traded instrument needs to touch the strike price just once before expiration to make money. There is a target above and below the current price, so traders can pick which target they believe will be hit before the expiration date/time.

Meanwhile, a “range” binary option allows traders to select a price range the asset will trade within until expiration. A payout is received if price stays within the range, while the investment is lost if it exits the range.

As competition in the binary options space heats up, brokers are offering additional products that boast 50% to 500% payouts. While product structures and requirements may change, the risk and reward is always known at the trade’s outset, allowing the trader to potentially make more on a position than they lose. Of course, an option offering a 500% payout will be structured in such a way that the probability of winning the payout is very low.

Unlike their U.S. counterparts, some foreign brokers allow traders to exit positions before expiration, but most do not. Exiting a trade before expiration typically results in a lower payout (specified by broker) or small loss, but the trader won’t lose their entire investment.

The Upside and Downside

Risk and reward are known in advance, offering a major advantage. There are only two outcomes: win a fixed amount or lose a fixed amount, and there are generally no commissions or fees. They’re simple to use and there’s only one decision to make: Is the underlying asset going up or down?

In addition, there are also no liquidity concerns because the trader doesn’t own the underlying asset and brokers can offer innumerable strike prices and expiration times/dates, which is an attractive feature. The trader can also access multiple asset classes anytime a market is open somewhere in the world.

On the downside, the reward is always less than the risk when playing high-low binary options. As a result, the trader must be right a high percentage of the time to cover inevitable losses.

While payout and risk fluctuate from broker to broker and instrument to instrument, one thing remains constant: losing trades cost the trader more than they can make on winning trades. Other types of binary options may provide payouts where the reward is potentially greater than the risk but the percentage of winning trades will be lower.

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Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker!
    Perfect Choice For Beginners and Middle-Level Traders!
    Free Demo Account! Free Education!

  • Binomo
    Binomo

    Honest broker!

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