Binary options are an easy way to trade on small price fluctuations in a large amount of assets like forex, stocks, commodities and futures, but a novice trader needs to understand the risks and rewards of these often-misunderstood instruments. Binary options are not the same as traditional options. If you will trade binary options, you will see that these options have different payouts, fees and risks.
Binary options are classed as exotic options, but the advantage of binary options is that they are are very simple to use and easy to understand. The most common binary option is a “high-low” option. Providing access to stocks, indices, commodities and foreign exchange, a high-low binary option is also called a fixed-return option. This is because the option has an expiry date/time and also what is called a expiry 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 is paid a fixed return regardless of how much the instrument moved. A trader who wagers incorrectly on the market’s direction loses his investment.
If a trader believes the market is rising, he would buy a “call option” If the trader believes the market will go down, he shall buy a “put option” . For a call to make money, the price must be above the opening price at the expiry time. For a put to make money, the price must be below the opening price at the expiry time. The strike price, expiry, payout and risk are all disclosed at the trade’s outset. For most high-low binary options outside the U.S., the opening price is the current price or rate of the underlying financial product, such as the S&P 500 index, EUR/USD currency pair or a particular stock. Therefore, the trader is wagering whether the future price at expiry will be higher or lower than the current price.
There is an upside to trading binary Options, but it requires some perspective. A major advantage is that the risk and reward are known. It does not matter how much the market moves in favour or against the trader. There are only two outcomes: win a fixed amount or lose a fixed amount. Also, there are generally no fees, such as commissions, with binary option trading. The options are simple to understand and easy to use, and there is only one decision to make: Is the underlying asset going up or down? There are also no liquidity concerns, because the trader never actually owns the underlying asset, and therefore brokers can offer innumerable strike prices and expiration times/dates, which is attractive to a trader. A final benefit is that a trader can access multiple asset classes in global markets generally anytime a market is open somewhere in the world.
The major downside of binary options is that the reward is always less than the risk. This means a trader must be right a high percentage (at least 55 %) of the time to make profit. While payout and risk will fluctuate from broker to broker and instrument to instrument, one thing remains constant: Losing trades will cost the trader more than he can make on winning trades.