Binary options is one of the most recent investment vehicles to hit the financial markets.
A binary option is a type of option where the payoff is either a fixed amount of some asset or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. Thus, the options are binary in nature because there are only two possible outcomes.
There are many binary options articles that explain how binary options developed over the years. Binary options contracts have long been available over-the-counter (OTC) i.e. sold directly by the issuer to the buyer. They were considered to be “exotic” instruments and there wasn’t any liquid market for trading these instruments between their issuance and expiration. They were often embedded in more complex option contracts.
Things changed over the years and by 2008 binary option trading platforms began offering a simplified version of exchange-traded binary options. These platforms offered standardized short-term binary options with a pre-determined profit/loss, that could not be liquidated (buy or sell to close) before expiry.
Articles on binary options reported that by the end of 2011, there were an estimated 90 such platforms (including white label products) in operation, offering options on some 125 underlying assets. Binary options brokers today offer even more than this number and compete vigorously for the position of the broker offering the most assets to option buyers.
Most binary option brokers offer detailed explanations about how this instrument works. Binary options articles provide additional information. Binary options are actually easy to understand and are often referred to as a fixed-return option. They provide access to stocks, indices, commodities and foreign exchange, and have an expiry date, a time and a strike price. If a trader wagers correctly on the market’s direction and the price at the time of expiry is on the correct side of the strike price, the trader receives a fixed return regardless of how much the instrument moved. A trader who wagers incorrectly on the market’s direction ends up losing a fixed amount of her/his investment or all of it.
If a trader believes the market is going higher, she can purchase a “call.” If she believes the market is going lower, she can buy a “put.” For a call to be profitable, the price must be above the strike price at the expiry time. For a put to be a money maker, the price must be below the strike price at the expiry time. The strike price, expiry, payout and risk are all disclosed up front. The payout and risk may fluctuate as the market moves. A call that is “in the money” by an extreme degree has a good chance of finishing in the money if there is only a short interval before expiration. However, the pay rate out and the risk locked in by the trader when the trade was originally made will hold strong at expiration. This means different traders, depending on when they enter, may have different payouts.