A binary option is the type of trade options wherein the payoff is either all or nothing. Due to these characteristics, the binary options will be much easier to understand and trade options as compared to the traditional options.
The binary options are known as cash settled and a European style option, which means that they can only be used at the time of the expiration date. If in the event of expiration, the options settle in the money, the seller or the buyer of such option will not receive anything. This provides a known gain or loss risk assessment.
Unlike your usual options trading, the binary options trading provides a full payout due up to a single pip movement. Even though it is called “all or nothing”, nothing could mean something although this will also depend on the trading platform used. During the period of expiration, the owner of the option could earn a certain amount of payout even if the trade options expire “out of money.”
Sometimes, you might encounter binary options in another name. Like in the FOREX market, the binary options are also called the digital options. Here’s how to trade options on binary options.
Learn the Concept behind the Two Outcome Options
You should learn the concepts behind the two outcome options. If you are trading binary options, you should anticipate the expected course of the movement of the price of a certain asset. Unlike the traditional method of trading options, knowing the course of the movement of the price and the magnitude of the movement is really not required for binary options trading. If the investor will have an opinion about a certain asset and would like to place a trade, then he can trade through binary options.
Decide About your Position
If you are positive that the market price will increase and that the economic event will really occur, then go ahead and make a purchase. But if you think otherwise, then you should sell. If in case your insights are correct about the expiration date, then your payoff will be the settlement value of the contract.
Study How Price is Determined
The cost of the binary option contract is often equivalent to the probability of the event that will be happening. For instance, if the value of the contact is at $100 and the last trade of the contract was at $96, then this indicates that 96% of the market strongly believes that such event is going to happen and that the contract will therefore end “in the money”.
Know the Advantages of Binary Options over Traditional Options
Binary options are generally easier to trade since they will only require a sense of direction on the price as well as the movement of a certain asset. The traditional options on the other hand, would simply require a sense of direction and magnitude on the price movement. Here are several other things you need to know on the differences of the two:
· Binary options will have controlled risk on the reward ration and this means that the risk as well as the reward will be pre determined at the time that the contract is acquired. The traditional options on the other hand have no defined boundaries on the risk as well as the rewards and thus, the losses and the gains are limitless.
· The binary options trading provides almost all the trading as well as the hedging strategies that can be found when trading by means of the traditional options. But it maintains a more sophisticated trading functionality.
· Unlike the traditional option, the payout amount on binary options is not proportional to the amount by which the option will end up “in the money”. For as long as the binary options will settle in the money even with just one tick, regardless of how much is in the money, the winner will be rewarded with the entire amount of fixed payoff.
· The binary options provide contracts that are only for a short term period. In some markets, the binary options contracts often close several times all throughout the entire trading day, while there are others that could last even up to a quarter. This gives the trader several investment options and flexibility as the market would change in the course of time.
Find Out Where Binary Options are Traded
The next thing that you should do is to learn where the binary options are being traded. Trading binary options has become very popular in Europe and is extensively being traded in the EUREX and other European Exchanges.
In the US, there are few places where binary options are accepted. Among these is the Chicago Board of Trade, which offers binary options trading on Target Fed Funds Rate. In order to trade with these contracts, the traders should become a member of the exchange investors and they are required to trade options through such member in order to carry out a trade.
Find Out the Implicit Transaction Costs
It is also important to find out the implicit transaction costs before trading binary options. By comparison, a commission with only a few dollars in order to purchase thousands of dollars worth of stock as well as a few dollars to sell it and will cost only a fraction of a percentage point in returns which you will need to make up for in the skill in order to break even.
You also need to know the percentage of the time that you have to be correct in order to profit out of the binary options that you are contemplating. Find out the terms, such as the strike price for one side of the trade that you are contemplating and other side. If the two are far apart, then one would have to be able to predict successfully that certain underlying assets will either move far from what the option sellers would guess that such underlying assets will move far from what the option sellers have predicted. It is extremely rare and difficult to make a prediction about the way the market moves and thus, high transaction costs may end up with zero returns.