Lewis is a retired corporate executive, entrepreneur, and investment advisor in Texas. There are 7 references cited in this article, which can be found at the bottom of the page. A binary option, sometimes called a digital option, is a type of option in which the trader takes a yes or no position on the price of a stock or other asset, such as ETFs or currencies, and the resulting payoff is all or nothing. Because of this characteristic, binary options can be easier to understand and trade than traditional options. An “option” in the stock market refers to a contract that gives you the right, but not the obligation, to buy or sell a security at a specific price on or before a certain date in the future. If you believe the market is rising, you could purchase a “call,” which gives you the right to purchase the security at a specific price through a future date.
Also called fixed-return options, these have an expiration date and time as well as a predetermined potential return. Binary options can be exercised only on the expiration date. If at expiration the option settles above a certain price, the buyer or seller of the option receives a pre-specified amount of money. Some binary options will pay out if the share price is met during the determined period. Learn how a contract price is determined. The offer price of a binary options contract is roughly equal to the market’s perception of the probability of the event happening. Learn the terms “in-the-money” and “out-of-the-money.
For a call option, in-the money happens when the option’s strike price is below the market price of the stock or other asset. If it’s a put option, in-the-money happens when the strike price is above the market price of the stock or other asset. These are a type of option growing increasingly popular among traders in the commodity and foreign exchange markets. This type of option is useful for traders who believe that the price of an underlying stock will exceed a certain level in the future but who are unsure about the sustainability of the higher price.
A purchase that gives you the right to sell the security at a specific price until a future date. If you think the market is falling, you can purchase a “put. A purchase that gives you the right to purchase the security at a specific price through a future date. If you think the market is rising, you can purchase a “call. A contract that allows you to buy or sell a security at a specific price on or before a certain date in the future.
A “put” and a “call” are different options. A trader of binary options should have some feel for the anticipated direction in price movement of the stock or other asset such as commodity futures or currency exchanges. Within most platforms the two choices are referred to as “put” and “call. Put is the prediction of a price decline, while call is the prediction of a price increase. Evaluate the current market conditions surrounding your chosen stocks or other asset and determine whether the price is more likely to rise or fall.
If your insight is correct on the expiration date, your payoff is the settlement value as stated in your original contract. The return rate on each winning trade is established by the broker and made known ahead of time. Learn the advantages of trading binary options over traditional options. Binary options are generally simpler to trade because they require only a sense of direction of the price movement of the stock. Traditional options require a sense of both direction and magnitude of the price movement. No actual stocks are ever bought or sold, so the selling of shares and stop-losses are not part of the process.
Binary options always have a controlled risk-to-reward ratio, meaning the risk and reward are predetermined at the time the contract is acquired. Traditional options have no defined boundaries of risk and reward and therefore the gains and losses can be limitless. Binary options can involve the trading and hedging strategies used in trading traditional options. You should always conduct a market analysis prior to each trade.
There are many variables to consider when trying to decide whether the price of a stock or other asset is going to increase or decrease within a specific time period. Without analysis, the risk of losing money increases substantially. Unlike a traditional option, the payout amount is not proportional to the amount by which the option ends up ahead. As long as a binary option settles ahead by even one tick, the winner receives the entire fixed payoff amount. Binary options contracts can last almost any length of time, ranging from minutes to months. Some brokers provide contract times of as short as thirty seconds. Traders must know exactly what they’re doing.