Binary Options Investing vs. Gambling What is the Difference

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Binary options – trading, NOT gambling

This question has been repeated so many times that we thought it deserved a special section. A lot of people like to think that Binary Options is like gambling because you are basically investing your money on something that you simply cannot tell with a respectable degree of confidence. Since you are trying to predict whether the cost of an asset will appreciate or depreciate within a specific time period, you can either be right or wrong, regardless of what you may have learnt. Let’s take a look at whether this assumption is true or not.

What is Gambling

Gambling is essentially an investment into an activity in the “hopes” of winning something of a higher value. Gambling is extremely popular the world over; places like Las Vegas are frequented by millions every year who try to find that lucky break which will turn their thousands into hundreds or thousands or even millions. Of course such an outcome is tempting!

All you do is show up, place a bet and chances are you will walk away with enough money to make the rest of your life hassle free and comfortable. Popular forms of gambling include lottery, horse race, casino games like blackjack, roulette, bingo. There are even wagers which are placed on the outcomes of certain sports such as cricket and football, these bets include predictions such as who will win the toss, how much will the team score after a particular time period and whether a particular team will win or not.

The keyword in all the activities above is “hope”. The decision to place a wager is purely an emotional one and there is virtually no way that the gambler can even hope to get a clue regarding whether the eventual outcome will be in his or her favor. Gamblers often place large sums of money saying things like – “I just know it!” or “this is my lucky day”, hardly a well thought out decision. Gambling by its very nature is extremely risky and the odds from the get go are always stacked against you. Simply put, you are gambling if…

  • You have absolutely no way of knowing how the activity will turn out.
  • You are making financial decisions purely on an emotional level.
  • You did not bother to study the game you are investing in.
  • You believe that chance, luck or fate favors you.

Gambling vs. Investing in Binary Options

So does Binary Options fit the above description? Well for starters there is no way you can state with a hundred percent confidence that the outcome of the trade will go as you saw it, but the same could be said about anything else in life, ALL activities have some degree of risk attached with them and there is no way you can ever predict with total certainty that your plans will work out your way.

So there is no doubt an element risk that you might lose the amount you invested to purchase the trade. However, most people do not realize that part of Binary Options trading involves rigorous study of market trends, chart analysis and how assets tend to move from time to time. It also requires an understanding of binary options pricing. This is why those who bother to understand the market in general are the most successful at it.

Therein lies the difference between gambling and investing, while gamblers are emotional people, willing to lose money against a hopeful outcome, traders are intelligent analytical people who have rigid money management strategies and place trades in carefully selected scenarios which offer the highest chance of a positive return. If Binary Options could indeed be classed as gambling then all traders in stock markets are gamblers and surprisingly, many of them are some of the richest people on the planet.

Unlike gambling, in Binary Options you CAN predict with a high degree of confidence how an asset will move! While this does not mean that all the trades you place will win, there are ways you can turn most of your investments into winning ones.

Gambling Trading
Money is wagered emotionally. Money is invested intelligently.
Risk is maxed out. Risk is understood and accounted for.
Gamblers like to rely on luck. Traders like to rely on careful analysis and planning.
Predicting outcome is often impossible. Outcome is treated as a statistical probability.
Gamblers are easily tempted. Traders are inherently suspicious of too good to be true scenarios.

Mitigating Risk in Binary Options

Risk in Binary Options can be brought down systematically by a careful use of charts, market analysis and strategies. With the aid of charts you can understand how the price of an underlying asset is moving so that you can make an informed decision. When you have the history of how the asset has been behaving through a set period of time, you can at least gain an idea as to how it may behave in the next few minutes or hours.

Next, you can use strategies to reduce the risk as well. For instance, you could use a strategy called “Spreading” where you can duplicate a trade across a number of different binary option platforms. Since each of the five trades will be placed a few seconds to a few minutes apart from each other, it instantly increases your chances of scoring a winning trade on at least a couple of them. On an average you can hope to win 70% to 80% of all the trades that you will place when you make a use of the signals which you will receive from Option Bot 2 if you use spreading.

Avoid the Winning Streak Pitfall

One of the biggest errors which both seasoned traders and gamblers commit is getting carried away by winning streaks. A smart investor knows when to call it quits and move away, under no circumstance should you invest more money than you can afford to lose and the best way you can hope to win at Binary Options is by trading slowly and steadily rather than hunting for those special days.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Binary Options vs. Options

Binary Options vs. Options, if you are new to trading then you may be slightly confused.

What is a binary option and how is it different from a traditional vanilla option?

This is indeed an important question as one cannot really be expected to make money trading either without having a theoretical understanding of how they work and what characteristics they share.

You cannot simply jump into binary option trading without knowing where it came from. We will go through the differences and similarities between binary options and traditional options in depth.

What is an Option?

An option is a financial instrument that is a derivative on another asset. This means that is derives it’s value from the value of some underlying asset. An option gives the holder the right but not the obligation to buy or sell the underlying asset at some predetermined time in the future. This is why they differ from other derivative instruments such as Futures. The holder of the option does not have to execute on the underlying contract if it is not profitable for him to do so.

Options can be written on a range of financial assets from Equity, to commodities, Forex, interest rates and even bonds and credit ratings. Options contracts are by no means a new phenomenon in the financial world. They have existed for hundreds of years and first started being offered in ancient Greece as a way for farmers to hedge their olive crops. Since then, they have been used in commodity circles for a number of years.

People then started to trade options on equities (stock options) and interest rates (Swaptions). These then evolved into an asset class in their own right which culminated with them officially being traded on the Chicago Mercantile Exchange in 1973. This created a large market for them with full liquidity similar to how traditional stock markets would operate.

Some Option Fundamentals

Option theory can be quite a complicated discipline but there are a few fundamental factors that one needs to know about in order to trade them. Some of these are more relevant for quantitative traders than others but it helps to have an overview of them all.

Current and Strike Price

The Currency price (S) and the Strike price (K) are two really important inputs in determining the option price and payoff. The current asset price is self-explanatory and is the price that is prevailing in the market for the asset. The strike price is the agreed upon price that the option holder will either buy or sell the asset at expiry.

Time To Expiry

This is the predetermined time in the future when the option expires. If the trader has entered into a European option, then this is the only time at which they can exercise the option (their right) to either buy or sell the security. This is in contrast to the American option where a trader can exit at any time prior to expiry.

The option expiry time can range anywhere from end of month to a few years in the future. Option expiry time is also an important point in pricing options as it plays a large role in the time value of the option. This is the notion that, all things held equal, an option with a longer time to expiry is worth more.

CALL or PUT

When someone enters a CALL option, they are purchasing the right to buy the asset at some pre-determined rate in the future. When someone buys a PUT option, they are getting the option of selling some asset at some time in the future. Hence, one can think of the CALL option as a trader taking a bullish (long) view on the asset and the PUT option as the trader taking a bearish (short) view of the market.

Option “Moneyness”

There are two terms that you will hear frequently when trading options. Those are In-The-Money (ITM) and Out-Of-Money (OTM). In essence, what it implies is if it would be profitable for the trader to exercise the option at the current price level. When the trader holds a CALL option, it is in the money when the price of the asset (S) is above the strike price (K).

Conversely, a PUT option is in the money when the price is below the strike. Out of the money options occur when exercising the option is not worth it for the holder and they would rather let the option expire worthless.

Price Volatility

Option Volatility (σ) is also an important factor when pricing options. This is because volatility can impact the price movement of the asset to a large degree and hence the option price as well. Volatility is a measure of how much a price moves around a mean. Generally speaking, options on assets with more volatility are more expensive as there is more chance that the price will swing wildly in or out of the money

Payoff

At the expiry time of the option, the holder will get a certain payoff. This will only be positive if the option has indeed expired in the money. The payoff will be the difference between the asset price and the strike price (S-K) if it is a CALL option. The payoff will be (K-S) if it is a PUT option.

Premium

The option premium is another term for its price. The reason that it is termed a “premium” is because one can think of it buying protection similar to the protection that one buys with insurance premiums. When a trader buys an option, the maximum that they are going to lose on the trade is this premium amount.

Option Example

We will take a look at a graphical example of a call option payoff in order to help cement your understanding of how an option would work.

In the image on the right we have a CALL option. The price of the asset is plotted on the x axis and the Profit / Loss is plotted on the Y axis.

We can see that the strike price (K) of the option is at 110. Looking at the payoff structure, one can see why options have an asymmetric payoff. The maximum loss that the trader can lose is the option premium when the option is out of the money.

On the upside though, the potential profits from holding the option are unlimited. This is the reason why options can be such a profitable derivative instrument.

Of course, this is rather simplistic as the option price does vary according to the time to expiry and the volatility in the underlying asset.

Benefits of an Option

Given the nature of the payoff and the way that options are priced, there are a number of benefits from trading options. Although some of these are more applicable to sophisticated investors, retail traders can learn from them.

Leveraged Trade

The Trader is in effect taking a leveraged trade on the asset to the upside. When the trader pays the premium then they could theoretically gain a large payoff if their trading turns out the way that they predicted.

Maximum Loss

Options have a certain degree of surety around them as the trader knows with certainty the maximum loss that he / she is likely to incur in the case of a downside event. This is the option premium that was invested.

Unique Strategies

Given the asymmetric payoff that one can see for an option trade, this means that the trader can use a number of bespoke option based strategies. These include such strategies as bull / bear spreads and option flys

Trade any Asset

When trading an option, you don’t have to hold the underlying asset. Therefore a trader can take a position on an asset that they cannot physically buy. For example, if the trader wanted to take a long position on the S&P 500 index, they can merely by a call on the index

Trade Underlying Volatility

This may be more applicable for the sophisticated investors who would like to trade the underlying volatility of the asset. In the financial industry option trading desks are often termed “volatility” traders. This is because volatility has a large impact on option price and hence traders can take a view on it

What is a Binary Option?

Binary options share all of the same underlying factors as traditional vanilla options. When pricing binary options, the same inputs are used to determine its value. The only way in which they differ is their pay-out structure on expiry.

On expiry of a binary option, the pay-out of the option is only one of two outcomes. That is either 0 or 1 (100). This is why it is sometimes termed “binary” or “digital”. These are the basics of binary options and how their payoff is determined. This is in contrast to the vanilla option where the payoff is indeed variable on the upside.

We have included an image on the right that is the pay-out of a binary option on the expiry of that option. Unlike with the traditional options, the payoff is capped at a certain amount. This means that no matter how high the asset price goes, this will be what the trader will gain.

Binary Options have been traded Over the Counter (OTC) by large investment banks and hedge funds for a number of years. They were also considered quite difficult assets to trade due to the nature of their payoff. The large market makers who were trading Binary Options with millions in notional found it hard to hedge the binary outcome.

Retail Binary Options Market

It was not until about 2008 that Binary Options started to gain a large degree of interest from the retail market. Average investors who previously had traded Forex and CFDs now had the opportunity to trade a different type of instrument. They did not need to know about the underlying option theory in order to take a “bet” on the direction of the asset.

Binary Options trading then took on a different form and could allow traders to enter a trade with expiry times of as little at 1 minute which was unheard of in the option industry. Binary Option trades were also simplified down to the point at which the trader could merely decide whether the option was going to go up or down in the next few minutes.

Payoff was also determined as a percentage “win” on the trade. Hence, if the trade ended up in the money then the trade would get a payoff that ranged from 50%-80% of the amount that was staked on the trade. Retail binary options also operated as a European option variant where the trader had to wait until expiry. This is in contrast to most traditional vanilla options where execution can be done prior to expiry.

Indeed, there were a number of traders who merely traded binary options on a hunch and this was more gambling than investing. Binary Options trading morphed from a complicated derivative instrument that investment banks struggled to hedge into a quick and easy way for retail traders to enter the market.

Benefits of a Binary Option

Even though most traders sometimes treat binary options as a mere bet on the movement of the underlying instrument, they do enjoy this form of trading. Unlike traditional option trading, the trader does not have to monitor the underlying factors that impact on the price of the option such as those we mentioned above.

They don’t have to necessarily study the dynamics of option pricing in order to do relatively well trading binary options. They merely have to have a view on where they think the asset is likely to go based on a number of different trading signals and indicators.

Moreover, traditional option trading is not easily available to most retail traders. This is because there are usually quite large minimum account requirements to maintain a vanilla option account. However, Binary options brokers have much lower account requirements that start as low as $10 for some.

If you are a relatively new trader who would merely like to take a view on some asset over a very short period of time then you may be better suited to trading a binary option. However, if you have more funds available and would like to learn about trading options fundamentals then traditional vanilla options could be for you.

Common Misconceptions About Binary Options

There are many misconceptions about binary options, so it is important that traders understand exactly what they are–and are not–in order to use them effectively.

Here’s a look at some of the more common misconceptions.

Binary Options are Just Gambling

At least on the surface, binary options are structured just like a $100 bet on a football game: You buy the team you like or you sell the team you don’t. A binary is just a simple yes/no trade. The yes trade means you agree with the binary statement—that the market will reach a certain level before expiration, for example—while the no trade means you disagree. The pricing of the binary is between zero and 100 throughout the lifetime of the option.

Unlike football where the underdog will receive odds, the binary has a multitude of strike prices that have a variety of fixed odds.

If you buy a binary priced at 20, there is a low probability of it paying off. Your cost is $20, while your potential profit is $80.

If you sell a binary priced at 20, then there’s a high probability of it paying off. But your cost is $80, while your potential profit is $20.

You can trade binaries on stocks, futures, foreign currency and ETFs as long term investment and or flip them as a speculative short term trade.

Binaries can also be used as a hedge just like standard put options. The difference with binaries is that your potential loss is limited, you can have a very short time horizon and your payout is either all or nothing.

Binary Options May Be Bought But Not Sold

As you look at the various strike levels of a particular binary option, you’ll see the similarity to call options. As a binary buyer, you’re bullish about the underlying market. The binary at expiration is valued at $100 if underlying market finishes above the strike so the various strike levels will draw similarity to in the money, at the money and out of the money call options as to the relationship of the underlying to binary strike. The at the money binary will be priced around 50 and the pricing is limited to the trading range of zero to 100.

You will not find the binary option chain for the puts. To sell a binary you are taking the opposite view, you’re bearish the underlying market and think it will finish at or below the strike at expiration. So to sell a binary, you go short the binary at the trade price.

Remember that the binary contract is fully collateralized.

AUD/USD >.9140 (3PM) traded at 28

Binary Buyer: is long at 28 trade price and his cost is $28 per contract.

Binary Seller: is short at 28 trade price and his cost is $72 per contract.

Fully Collateralized: buyer cost $28 + seller cost $72 = $100 Expiration payout

You Are Required to Hold Until Expiration

Binary options are not buy and hold contracts until expiration. At any point prior to the expiration, the binary position can be offset to cut your trading losses or lock in an early trading profit. When you initiate the binary position, your initial trade cost is your maximum exposure, so you’re either long or short the binary at the binary trade price. In a long binary position, you want the price to rally to 100, while in a short binary position you want the binary pricing to sell off to zero.

Binary Options are Not Regulated

Many binary options that are traded over the counter outside of the US are not regulated.

In the US, there are three exchanges, regulated by the CFTC, offering binary options trading, Nadex being the first and largest for retail traders.

Binary Options are Not Transparent

If you are trading binary options on a regulated exchange, you will be provided accurate and up to date time and sales data on all bids, offers and trades throughout the trading session. That’s because the exchange is simply matching buyers and sellers on every trade.

Binary Options Requires Enormous Capital

All binary options are priced between $0 and $100 and the minimum amount to open an account with Nadex is $250. Since you are never trading on margin, your account always needs to have sufficient funds to cover the initial cost of the trade plus trading fees.

With binary options, the maximum risk and the potential profit are clearly defined to the terms of the trade assuming a favorable expiration payout. To trade on Nadex, the initial cost is a fraction of the leverage markets on which the Nadex products are based.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Like this post? Please share to your friends:
Guide How To Become Binary Options Trader
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: