Binary Options and Their Unique Characteristics

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Binary Options and Their Unique Characteristics

The word binary means two. A binary option contract is a simple derivative contract with only two possible outcomes.

Depending on the prevailing price of the asset at expiry, the trader either loses his entire investment or receives a pre-determined profit percentage.

Thus, binary option contracts are also referred to as fixed return options (FRO) or all-or-nothing contracts.

The value of a vanilla or regular option traded on an exchange keeps changing in accordance with the changes in the price of the underlying asset.

On the other hand, the value of a binary option contract is determined only at the time of expiry. It can be understood by a simple example provided below:

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Let us assume that a buyer purchases a call option contract for gold. Let the price of gold at the time of purchasing the contract is $1200 per ounce.

Let us assume that the expiry time is one day.

At expiry, if the price is above $1200, then the binary call option contract will result in a profit. The holder of the binary contract will receive up to 92% (depending on the broker) of the invested amount. If the price is below $1200, then the binary call option contract will expire worthless. The holder of the contract will lose his entire investment. The inverse is true in the case of put option contract.

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As it can be understood, there is no way to exit (some brokers offer such a facility, which we can discuss in later topics) in between.

In the case of vanilla options, which are traded on an exchange, the value keeps changing and a trader can exit any time in between. However, the difference between the price of the underlying asset at the time of entry and exit determines the value of a vanilla option and the corresponding profit or loss. On the other hand, a binary option holder will receive the pre-determined payout even if the price has moved only a few notches favourably in the direction of trade.

The following are the most important differences between vanilla and binary options contract:

Counter parties: The binary options contract is an Over-The-Counter (OTC) product. It is not traded in any exchange (apart from Nadex which offers a totally different structure). The contracts are offered by brokers who act as the sellers (writers). The retail trader will be the buyer (holder) of the contract. In the case of vanilla options, the exchange facilitates or provides a platform for two parties to buy (holder) and sell (writer) an option contract. As it can be understood, the broker (market maker as they are called technically) bears the risk by writing the contract in the case of binary options. In the case of vanilla options, the exchange simply supervises the trade and does not bear any price movement related risks.

Expiry: The binary option contracts are created by the brokers without the involvement of the regulatory bodies. Thus, binary option brokers offer a wide range of expiry periods starting from 30seconds. On the other hand, the structure of a vanilla option contract is determined by the exchange and regulatory bodies. Thus, generally, the vanilla contracts only have monthly expiries. Being an OTC market, the binary brokers are at full liberty to customize products to suit the demand of individual traders. It is not so in the case of vanilla options contract.

Range of options contract: The binary brokers not only offer contracts with multiple expiry periods, but also modifications in the settlement process. For example, in the case of a one touch option contract, as long as the price touches a specific level any time before the expiry of the contract, the trader will receive a fixed amount as profits. However, the vanilla option contracts follow the same standard structure.

Payout: As long as the price keeps moving in the direction of trade, the value of a vanilla option contract will increase. Thus, theoretically, the profits can be unlimited. However, sudden reversals before the expiry time will erode most of the gains. In the case of binary options contract, the trader will receive a fixed profit irrespective of the quantum of price movement in the direction of trade. For example, if a binary options trader has bought a put option contract for gold at $1200, then as long as the price trades below $1200 at expiry, the trader will bag the entire amount allotted as profit. Irrespective of whether the price trades at $1199.99 or $1100, the trader would receive the same fixed percentage guaranteed at the time of entering the contract. In the case of vanilla options, practically, the trader would only incur a loss if the price trades at $1199.99. The reason is that value of vanilla option contracts suffer from time decay. Binary option contracts do not face such an issue.

Other charges: Binary option brokers do not charge any other fees for executing a trade. On the other hand, vanilla option trades would involve exchange related fees and other taxes imposed by the state where the exchange is located. The binary options broker, being a counter party (writer) to all the trades, receives the entire investment of a trader as profit whenever an option holder loses the trade. Thus, the binary options broker does not levy extra charges for executing a trade. Reputed binary options broker mitigates risk through hedging and sophisticated algorithms. This protects them from losing a large amount of money when a trader wins consistently.

Exercise time and rights: The binary option contracts are purely speculative contracts. Thus, the buyer (holder) of the contract will not have any rights to exercise (no demand can be made to buy or sell the underlying asset at the price mentioned in the contract). The contract simply ends in a profit or loss at expiry. The market maker or broker bears the entire risk. On the other hand, vanilla options traded through an exchange offer exercising rights to a trader. The trader can claim his right to buy or sell the underlying asset at or before the expiry.

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.

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.

Binary Options Characteristics

Hello traders! Today I’ve prepared for you 11 things that I think perfectly describe what binary options are and how they work. I noted really just the most important ones which are elementary. So let’s look at it.

  • Unlike trading on Forex, binary options traders are not limited by the leverage effect. (Leverage effect allows you to trade with more resources than you have, so your profit or loss can be far greater. In the most cases, the foreign capital is provided by a broker and of course it is not for free.)
  • You know your profit or loss from individual trades ahead and you can’t lose more money than you invest (for Forex it is the exact opposite).
  • A number of your profits from particular binary option does not depend on the amount of the price change of the underlying asset. (What I am trying to say is that any price change will not change the profit. Your profit is set ahead and it can’t change.)
  • The payouts and losses are clearly defined in advance for all binary options trades!
  • Most of binary options brokers listed on our website (see List of binary option brokers) offer early close options. When the traders consider the price favorable, this feature allows them to exit the trade at any time prior to closing time. That allows traders to gain quick profits from any trade or minimize their losses. For example, you can sell the option when you see the trade is not going to be profitable and you will not lose 100% of the money from your trade.
  • All listed brokers on this page (and most of all other brokers) are offering payouts from 69 to 90% for a huge variety of assets. To see the exact payout percentage you have to visit the broker internet page.
  • Binary option trading is quite easy. You even don’t need any previous experience with trading. (It is significantly easier than Forex trading.)
  • There are no hidden fees on binary option trading (when we talk about regulated brokers). Occasionally there is a fee for inactivity or withdrawals fee, but that doesn’t happen very frequently. For example, the IQ Option broker offers withdrawals for free.
  • You don’t have to be an experienced professional trader, mathematical genius nor supernaturally smart individual to profit from binary option trading. Literally, everyone can successfully trade binary options, whether you’re a student, a mother on maternity leave or accountant.
  • All binary options trades have just two possible outcomes. That’s why we are calling them binary. (The binary system also only has two possibilities, 1 and 0.)
  • When you open a position with the underlying asset, it doesn’t mean, that you are buying it. You only predict the direction of price change of the asset.

I hope you like these characteristics of binary options. It was written mainly for novice traders and people, who don’t know binary options at all. Do you have any other idea about the characteristics? Leave a comment! Anything you share with us can help novice traders. Thank you ��

Author

More about the author Step

I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

2 Responses to “Binary Options Characteristics”

Good blog post. I want to thank you for interesting and helpful information and I like your point of view. Thank you!- I love to read this type of material Good and attractive information I take from it.. Thank you for posting such a good article.

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