- Binary Options refer to a form of financial speculation wherein investors forecast the price movement of a given stock, index, or commodity over a predetermined period. Rather than purchasing the asset itself, traders merely speculate on whether the value will increase or decrease.
- This form of trading is distinguished by its binary outcomes, as investors must decide whether their prediction will be accurate or incorrect.
- In addition, traders are able to determine the amount to invest in the option as the option’s price is not fixed, but the return is.
Types of Binary Option Instruments #
- Brokers offer a range of binary options instruments to trade in the financial markets.
- These include High/Low, One Touch, and In/Out Boundary options, each of which has its own set of advantages and purposes.
- High/Low options involve predicting whether the market price will close above or below the current price, while One Touch options involve predicting whether the market price will reach a certain amount before expiry.
- In/Out Boundary options have a target range and their outcome depends on whether the market price is inside or outside of the boundary at the option’s expiration.
- Options yielding a fixed rate of return upon expiration offer investors three potential outcomes: In the Money (ITM), Out of the Money (OTM) or At the Money (ATM).
- For ITM options, returns are typically on the order of 70% of the initial amount invested, meaning that a $100 investment would return $170.
- OTM options, on the other hand, typically do not offer any refund.
- Lastly, ATM options are associated with a full restitution of the initial investment.
In the Money Expiry #
- The expiration of an option wherein the holder stands to accrue a profit is termed as “In The Money” (ITM).
- An option is said to be ITM when it exhibits a profit for the investor upon expiration.
- The below conditions would result in an option expiring ITM:
- High options expire ITM when the market is higher than the specified target price, while low options expire ITM when the market is lower than the target price.
- Touch options expire ITM if the market reaches the target price at any time prior to expiration, while No Touch options expire ITM if the market fails to reach the target price before expiry.
- For Boundary options, they expire ITM when the market lies between the specified boundary range, while Out Boundary options expire ITM when the market lies outside the boundary range.
Out of the Money Expiry #
- Options expiring OTM will result in a net loss for the trader in the following scenarios:
- high options when the market at expiration is lower than the target price,
- low options when the market at expiration is higher than the target price,
- touch options if the market price never reaches the target price prior to expiration,
- no touch options if the market price reaches the option’s target price at any time before expiration,
- inboundary options when the market at expiration is outside their boundary range,
- and outboundary options when the market at expiration is inside their boundary range.
At the Money Expiry #
At-the-Money Expiry (ATM) occurs when an option’s target price is equivalent to the market rate at expiration. Upon expiration of such options, brokers will remit the initial investment to the trader.
- Options will expire ATM under the following circumstances.
- An option may expire At The Money when the market price at expiration is equivalent to the target price.
- High and Low options will reach this point when the market at expiration is the same as the target price, while In Boundary and Out Boundary options will expire ATM when the market is at either the upper or lower boundary.
- Touch and No Touch options are unable to expire At The Money.
Binary Options vs Retail Forex #
- Retail Forex trading and binary options are two distinct types of financial trading instruments.
- Both involve the buying and selling of assets, but they differ in a number of ways.
- The type of asset being traded.
- In retail Forex trading, traders buy and sell currency pairs, such as USD/EUR or GBP/JPY.
- Binary options, on the other hand, involve the purchase of a contract that will either yield a fixed payout or no payout at all, depending on the outcome of the trade.
- The amount of risk involved.
- In retail Forex trading, traders can use leverage to increase their potential profits, but they also increase their risk of loss.
- With Binary options, the maximum loss possible is the amount invested in the option.
- The timeframe associated with these two types of trading is different.
- Retail Forex trading can be conducted over long periods of time, while binary options typically have expiries of minutes or hours.
- The type of asset being traded.
- Binary option trading is simpler than retail forex trading in some respects, but more difficult in others.
- On the simpler side, the trader only needs to choose whether the underlying asset will rise or fall in value within a specific time frame.
- This is in contrast to retail forex trading, which requires a more thorough understanding of fundamental and technical analysis, as well as a more sophisticated approach to risk management.
- Binary options trading is more difficult because:
- Binary options trading is an all-or-nothing proposition, the risk of loss is much higher than with retail forex trading.
- With binary options, traders must place a predetermined amount of money at stake, and then choose whether the price of the underlying asset will move up or down within a specified time frame.
- If the prediction is correct, the trader stands to make a profit; however, if the prediction is incorrect, the trader will incur a loss.
- This situation leads to a higher risk of loss compared to traditional trading, as there is no ability to partially close a position or set a stop-loss order.
- Additionally, the limited time frames of binary options can make it difficult to accurately gauge the direction of the market, contributing to the increased risk.
- As such, binary options trading requires a higher level of risk management, as well as an understanding of how to manage losses.