by Amanda Harvey
What is Binary Option Trading?
Trading binary options involves the use of option contracts which are designed to culminate in one of two possible outcomes; hence the name binary. These options are sometimes referred to as all-or-nothing-options, as upon expiry, they will either result in a predetermined pay-off or otherwise nothing at all.
With binary options, there are no decisions to be made after purchasing the option. Unlike other forms of options, they do not need to be exercised, and will automatically reach their conclusion on the date of expiration. This type of trading offers perceived simplicity, as it just involves predicting whether or not a stock will move a certain amount within a set period. It should be understood, however, that adequate research should be undertaken to ensure that the trade is not taken as a 50/50 gamble.
What are the Types of Binary Options?
Trading binary options focuses primarily on two types of binary options. One is called a cash-or-nothing binary option. This option is purchased with a strike price; a price the underlying stock must reach or exceed in order for the option to attain its payoff. The payoff is also designated in the contract, and in this case, is a fixed amount of cash. The second type of option available for trading binary options is the asset-or-nothing binary option. The payoff for this type of option, if it exceeds the strike price on expiration, is the value of the underlying asset.
Using Binary Call or Put Options
An example of binary option trading with a cash-or-nothing option is for the trader to buy a call option on a stock with a strike price of $35 with a payoff of $300. As a call option is taken with the assumption that the stock price will rise, the stock must be trading over the strike price of $35 on expiry of the option to attain the payoff of $300. This option would then be classed as being “in the money”. If the stock is trading at the strike price of $35 on expiration of the option, this option is then deemed “at the money”. The payoff is not achieved, but the premium is returned to the trader, making this a break-even trade (minus costs incurred).
Using the model of asset-or-nothing when trading binary options, let’s consider a trader taking a put option on a stock with a strike price of $70. A put option is a wager that the stock price will drop, so for this option to attain its payoff, the stock must be trading below $70 on expiration of the option contract. If the stock is trading at $68, the trader receives this value. If the stock is trading at $70, their premium is returned, but if the stock price is above $70, the option expires worthless.
Binary Option Trading Platforms
Although binary options are sometimes traded on regular exchanges, many of these options are traded over the Internet, and are unregulated. When trading binary options through a non-regulated platform, a trader should beware of possible fraud. Binary options are available through the American Stock Exchange (Amex) and the Chicago Board Options Exchange (CBOE) for traders wishing to participate in trading binary options in a standardized environment.
Criticism of Binary Option Trading
Because of the “all-or-nothing” aspect of binary options, and the proliferation of websites offering “bets” in the form of binary option trading, this type of trading is often viewed as simply a form of gambling. To be fair, there will always be those who view the entire stock market as speculation, and those may well be the same people who will keep their money in the bank or even under the mattress.
Binary option trading is a type of trading which can be used as part of a trader's overall investment strategy. As with any form of trading, to be successful, the trader must be informed, have a realistic plan that allows them to select and execute beneficial trades, and ensure that they trade in arenas which offer the best investor protection.