Basically, binary options are the type of options that leave you only two outcomes: either you win get a fixed amount of money, or you lose and get nothing. Binary options enable you to trade using minute amounts of money and at significantly lower risk, much like other options; the difference is the limited number of outcomes provided by the former.
Types of binary options
There are two basic types of binary options: the cash-or-nothing binary options and the asset-or-nothing binary options. The difference between the two is that the cash-or-nothing binary option offers payout in the form of a pre-determined sum of money, while the asset-or-nothing binary option offers to cash you out in accordance with the value of a security in question.
The way things work
Here is how it works: binary options are usually priced between 0 and 100 dollars based on the probability of success. The lower they are priced, the less likely the outcome they offer. For example, the probability of a security to rise in value within the next 24 hours is estimated at 70%, so the binary option on that can be bought for 70 dollars – and since you like the odds, you’ve decided to buy a binary option on that outcome. Your counterparty has to put up the other 30 dollars (their assumption is that they have a 30% chance of success), bringing the total to 100. Note that if you feel lucky, you could take the 30% option instead, for an even greater payout, as long as it comes true. In any case, if you win, you get the 100 dollar payout – your bet plus the remainder; if you lose, you get nothing. It’s as simple as that.
It is impossible to overstate the fact that the security in question is of no concern to you; you only own a binary option on its price movement, not the value itself, and certainly not the security in question. That means you get no say in anything that might affect its value, and no stake other the potential payout for your option. You may be able to sell it off before expiration, but only if you find a buyer so don’t get your hopes up unless you have a reason to.
On the other hand, some brokers have resorted to using binary options as a hedging tool, betting against the stocks in their portfolio and using the winnings to offset the potential losses. Or bet on those same stocks and increase the profits, but we’ll get to that some other time.
Binary options are taking the financial markets by storm. Being able to use an investment platform all by yourself with no background in economics or business is frightening to most professionals, and appealing to everyone else. Just be wary of unregulated markets, and make sure your counterparty is legitimate and reliable, or you may lose even if you win.