Binary Options Basics: History, Asset Types and Workings

For many years, trading the financial markets was the reserve of financial institutions and professional investors only. The advent of the internet brought currency trading to the individuals, but still, a strong understanding and experience of the markets was needed as the risk to the beginner was multiplied by the leveraged trading, which meant it was very easy for the novice to lose much more than they invested.

Binaries have in fact been around for a number of years and are available to purchase ‘over-the-counter’ directly from the seller. However, in 2008 the Securities and Exchange Commission (SEC) granted permission for the trading of these options to be listed in the US markets. This has fueled a rapid increase in the number of brokers offering online trading services for these options. The way these options were structured  also made them one of the easiest way to invest in the financial markets. Couppled with the opportunity to earn high returns within a relatively short period of time, this gave rise to a boom in the market for these non traditional options.

So What Are Binary Options?

Binaries are at thier simplest form, contracts which offer a fixed return for predicting how the price movement of a certain currency, stock, commodity or index will move over a predetermined period of time. The duality aspect, the fact that there can only be two possible outcome for these contracts is what gives them thier name.

 

A trader will receive a payout predetermined at the onset of the contract if their prediction is correct and they finish ‘in-the-money’ or they will lose a predetermined portion of their original investment if their prediction at the contract expiry finishes ‘out-of-the-money’.

Sometimes referred to as ‘digital options’, ‘fixed return options (FROs)’ or ‘all-or-nothing’ options, each option is made up of 4 elements:

1)       The Asset

Referred to as underlying assets, the trader does not actually purchase the asset itself and never actually owns them. Instead, the trader purchases the option to buy an asset particular asset. The assets can be anything from a whole of stocks, currency pairs, market indices, commodities and even government bonds.

2)        The Contract Length

All option contracts have a set expiry time. Whereas many traditional types of investing require an investment that can last up to several months before a return is produced, these non traditional option contracts can be anything from as little as 5 minutes before expiration up to 7 days.

3)       The Prediction

All a trader has to do is make a prediction in which direction the price of an asset will move in before or at the time of the contract expiry. There are generally three methods involved:

The High/Low instrument:

Choose ‘High’ if you think that the price of an underlying asset at the time of expiry will be higher than the current price.

Choose ‘Low’ if you think that the price of an underlying asset at the time of expiry will be lower than the current price.

The Touch/No Touch instrument:

Choose ‘Touch’ if you think the price of an asset will touch a target price at any time before the option expires.

Choose ‘No Touch’ if you think the price of an asset will not touch a target price at any time before the option expires.

The Boundary instrument:

Choose ‘In’ if you think the price of an asset will close inside the range formed by the upper and lower target prices at the time the option expires

Choose ‘Out’ if you think the price of an asset will close outside the range formed by the upper and lower target prices at the time the option expires.

4)       Investment Amount

The final element to the option contract is the amount to invest.  Every trade is for a fixed amount specified by the trader at the outset of the trade. It is important to note that the trader, unlike traditional forex, will never lose more than he originally invested.

 

Why Trade Digital Options?

There are many reasons why more and more people from all walks of life are trading this type of options.

Simplicity – Just simple yes/no type investment decisions are all you need to make, meaning anyone can trade the financial markets in an uncomplicated fashion.

Trade in All Conditions – It doesn’t matter if the markets are rising or falling, a binary trader can profit any market conditions. In fact, the more volatile the markets, the more profit opportunities as large swings in price create more chances to for returns than flat markets.

Regulated – Regulation has been only recently brought in to regulate the trading of this type of options. This helps to make the trading enviroment safer and more protected for investors.

Limited Risk – Unlike traditional Forex, there is no leverage involved which means you can only lose a proportion of the amount you invested and no more. This allows the trader to determine the risk levels and can keep the overall exposure relatively small.

Fast Paced – Expiry times for an option can be as little as 5 minutes with possibilities to close a position early to secure the profit or limit the loss. This makes it possible to make literally hundreds of trades throughout a day.

Affordable – Because you are not buying the underlying asset itself, rather just investing in the prediction of its price movement. This makes the investing in expensive assets like Gold, Apple Stock and Oil affordable to the average trader and opens up markets previously inaccessible.

High Returns – One of the key components to the success in popularity of binary options is the fixed returns they offer. A typical option, lasting from 5 minutes to a couple of hours, can yield up to 55 – 90% if predicted correctly. These short terms, high yield returns can mean the trader can accumulate substantial profits over the course of just one trading day.