Binary options trading is not at all like regular options investing, even though it carries the same titles such as "calls" or "puts". On the upside, the pricing and profit components are far less complicated because time decay and changing options prices is not an issue. Not only that, but once you place the trade, there are no more emotional or subjective judgements to make about when or whether to exit.
There is no exit strategy - only a fixed amount win or a loss when the time expires. Many traders like this 'fixed payout' characteristic of binary options trading because it is simple to understand and provides a level of certainty.
On the downside, binary trades are normally very short term speculative trades based on where the underlying financial instrument is expected to be within a short time. This could be anywhere from 1 minute away, to a week in the future.
If the underlying is where you anticipated, you receive a fixed payout; if it's not, you lose most, usually all of, your investment amount.
The word "binary" means "two" so these types of options are well named. There are only two outcomes - you get paid or you don't. Sometimes they are called all-or-nothing options, digital options or fixed-return-options (in the USA).
This being the case, opportunities for risk management through stop losses, taking profits at a time of your choosing, adjustments etc. are not available to you. Consequently, the nature of binary options trading is much closer to gambling than investing.
In some ways you could think of it like betting on a horse race. The thing is, there are only two horses in this race - one is called "up" the other "down". If you pick the right one, you win; if not, you lose about 85 percent of the amount you risked on the trade.
Binary options trading usually has a good return on risk percentage - usually between 70-90 percent profit and that ultimately means that providing you get the required number of winning trades, you make an overall profit.
Binary options can also be used for short term range trading. Instead of your objective being that the price will be above or below a certain price level, you're now speculating that the price of the underlying will trade within a specified range during an agreed period of time. These are called "hit or miss options".
The trader chooses the price range and the time frame and the broker then creates a price. If the underlying trades within the price range during the short time frame specified, you have a "miss" (because it doesn't hit the boundaries) and get paid.
Unlike regular options, the pricing of binary options excludes the component of implied volatility and this means you don't need to analyze the price given to ensure there is value in the binary call or put options you intend to purchase.
The important thing is to have a plan which includes an appropriate return on investment for winning trades that is sufficient to cover the anticipated number of losses. For example, a minimum 70 percent profit on each winning trade and 10 percent loss on losing trades means that you need to get 6 trades out of 10 right in order to make an overall profit. If you accept less than 70 percent ROI then the required number of profitable trades will increase. This however, is on the assumption that all your trade amounts are of equal value.
Another strategy would be to start trading with a small amount - if it wins then you walk away feeling good. If it loses, then your next trade amount must be large enough so that the advertised profit percentage will cover your loss trade (or trades) and also make your desired profit target.
An example would be:
First trade offering 170 percent return - $20 / lost ... next trade must be at least $52 to cover the $20 loss and make an overall profit. This can be a good binary options trading system, providing that you have a sound money management plan and you don't experience too many losing trades in a row.
Binary options are never exercised so you will never be landed with the underlying financial instruments at expiration date. The result is really simple - you either get paid or you don't. They are usually European-style options because they are only settled in cash at expiration. The payout is either cash-or-nothing or asset-or-nothing. In both cases, you are paid in cash, which is the value of the asset.
You can do binary options trading can on stock indexes, currency pairs or individual stocks. Currency pairs are most often favored because unlike many other securities, they are highly liquid and trade 24 hours a day.
Suppose it's 11am and the EUR/USD currency pair is trading at 1.3480. You believe that it will close at or above 1.3480 by 11.15am today. So you choose the amount you wish to invest - let's say $100 - and select "calls" (some brokers simply call it "up" or "down").
If the EUR/USD is at or above 1.3480 come 11.15am, you get paid your original investment amount plus an extra 70 percent on top. Below 1.3480 and you get nothing (some brokers pay you about 15 percent). At 11.15am the spot price is 1.3495 so you're happy - you walk away having turned your original $100 into $170.
The simplicity of binary options trading has made it attractive to speculative traders and their introduction in July 2008 has opened up yet another way to trade options.
If this way of trading options interests you, first step is to sign up with a reputable binary options broker. There are some scammers out there so do your research first - and make sure that it's easy to withdraw your profits.
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