What Is A Binary Option?
A binary option can be defined as a financial instrument with payoff being either a fixed amount or nothing. It is based on a system of a yes or no question. What this means is that a binary option offers you a well-defined risk and a clear outcome of what you can expect on every trade you enter into. Every binary option trade start with this question.
Is the market going to close above a particular price at a particular time?
If you answer yes, then you can invest in the option and buy it. Otherwise if not, you can sell the option. The price you pay for a binary is between $0-$100, and as in any other tradeable market, it involves a bid and ask price.
When thinking about it, one can easily come to the realization that binary options are a reflection of how we think of things in our lives. We either get a yes or no, and things either happen or they do not. When entering into a trade, the payout will reflect either a yes, which means taking it all, or a no, which means losing at all, at expiration time.
What you can also do is close a position earlier in order to lock it in for profit or to limit your losses. If you are an active trader, you would most probably be scanning the market every day, as you are dealing with complex issues on a frequent basis.
As such when you trade binary options, you want to be dealing with a broker who removes complexities and make things simple. A good broker like IQ Options for instance knows that you would want to focus on the market and on your position, and not on a lot of unnecessary products.
How Do Binary Options Work?
When learning about how binary options work, there are 3 concepts that are vital: the time of expiry, the strike price and the underlying market. If you allow yourself to become familiar with those 3 concepts, you will understand the basics of binary options.
The amount of money you pay is the absolute maximum that you can also lose. For that reason, we say that the risk you undertake is capped. At times you might not want to wait until the time of expiration and might want to close your position to lock profits in earlier.
First, you would want to pick an asset that you’d want to trade in. Each one of those assets would be based on an underlying market, with the trade based on the price movement of that market.
Then you’d want to find a strike price that you’re comfortable with. The strike price is the level you predict the market price will be at expiration. Either above or below.
Afterwards you select a time of expiration. This is the moment of revelation for every trader, because the value of your binary option is determined here. Also you should make sure to choose an options broker who has a fast trading execution. One of the fastest to choose from are IQ Option and Experts Option. If you want to learn more about this broker you can find on overview of IQ option here.
How Risky Are Binary Options?
The good thing about binary options is that you are always able to know the risk reward ratio before you start trading. Since your trade is paid for upfront, you cannot lose more than you paid for, and will always know the maximum potential in profit for each trade.
Let’s explain exactly how each trade goes:
Let’s say you buy a binary options contract for $45, in the hopes that it will end at $100, thus with a profit target of $55, ($100-$45=$55). You will never incur a loss bigger than $45, no matter how much the market moves.
What makes trading more difficult is complicated fee structures, payout structures that are confusing and margin requirements that are hard to understand.
How Are Binary Options Regulated In The US?
The Commodity Futures Trading Commission (CFTC) regulates all binary options trading. As such binary options can only be traded in the US on a Commodity Futures Trading Commission (CFTC) regulated exchange.
Nadex is a full-service exchange and is regulated by the CFTC. They are also designated by the CFTC as a Designated Contract Market and Derivatives Clearing Organization. They match buyers and sellers in a secure manner.
Binary Options Trading Example
At expiration a trader might be hoping for the following:
- If the market expires at or below 1.1700 at $4AM PST, the seller will receive the $100 payout.
- Should the market be a tick or more above 1.1700, you will receive the full payout, as you are the buyer.
Should you not want to wait till expiration, you can still close your position at current market price. The profit or loss you will incur is determined by the difference between the entry and exit prices.
As each binary option actually reflects a question, the question in this case would be: Will the EUR/USD close above 1.17?
This is shown as: EUR/USD > 1.1700
