Binary options are a relatively new method of investing and multiplying capital. Unlike other financial instruments, these types of options are easy to understand, even for novice investors. It is not surprising then that there is a growing number of people interested in binary options trading. So what is investing in binary options about? How to trade them? What should you watch out for? You will find out later in this article.
What are binary options?
Binary options (also known as digital options, bet options, all-or-nothing options) are a financial derivative instrument in which the investor predicts whether after a certain period (from several seconds to even several days) the price of a given asset will be above or below the price level from the moment of placing the order. The value of binary options depends on a specific underlying asset, for example, the price of a currency pair. Thus, trading with binary options is based on speculation – for this reason, they have gained the name of All-OR-Nothing options.
CALL and PUT options – what is binary options trading?
There are different types of binary options on the binary options market. Among the most popular are CALL and PUT options, which are briefly discussed below.
CALL options – an investor who bets on the increase in the price of a given underlying asset (most often currency) buys a CALL option. In a situation when at a predefined time (the so-called option expiry time) the price of the underlying asset rises above the strike price (the option expires in-the-money), the investor receives a predefined level of profit.
PUT options – the investor who bets on a drop in the price of a given underlying asset (most often currency) buys a PUT option. In a situation when at a predetermined time (the so-called option expiration moment), the price of the underlying asset drops below the strike price (the option expires in-the-money), the investor receives a predetermined level of profit.
Although investing in binary options is not necessary to have deep knowledge of the financial market. It is worth having at least minimal understanding of it and keeping track of the currency pair rates.
Binary options trading – key terms
To better understand the mechanism of binary options, it is helpful to familiarize yourself with other terms used in relation to them. In addition, to CALL and PUT options, the following terms are used in binary options trading:
- in-the-money – refers to a situation when a binary option has expired and made a profit for the investor. For example, for a CALL binary option, the option will expire in-the-money if the underlying asset’s price is above the strike price at the time of option expiration. For PUT binary options, the option will expire in-the-money if the underlying asset price is below the strike price at the time of the end;
- out-the-money – the binary option has expired, but the investor has lost all the money invested in the option instead of gaining. For example, the option will expire out-of-the-money for CALL binary options if the underlying asset price is below the strike price when the option expires. On the other hand, the option will pass out of the money for PUT binary options if the underlying asset price is above the strike price at the time of option expiration;
- at-the-money – a binary option has expired without profit or loss for the investor, i.e. at the time of expiration, the price of the underlying asset was equal to the strike price of the option;
- option expiration time ‒ a predetermined time at which the option expires;
- stock strike price – allows you to determine whether an option has expired in-the-money or out-the-money.
How to trade binary options?
To start trading binary options, you first need to open an account with one of the popular brokers. Creating an account is usually free. After verifying your account, you should deposit the funds you intend to trade by investing in binary options. However, it is worth keeping in mind that although many brokers and trading platforms are available in the market, only a select few allow binary options trading.
A given binary option is initiated by purchasing it from a broker at the current price. When the option is purchased, its expiration date is specified. The investor then indicates whether the option will rise (CALL) or fall (PUT). With a binary option, only two operation outcomes are possible: a fixed amount of profit made when the option expires “in-the-money” or a fixed amount of loss when the option expires “out-the-money”.
Binary options trading – is it possible?
The high risks associated with trading binary options meant that they soon began to cause quite a bit of controversy. As a consequence, on July 2, 2018, binary options trading was banned for non-professional investors throughout the European Union.
Professional traders can still trade binary options, also with brokers registered in the EU. However, to get the status of a professional trader, specific requirements must be met.
In conclusion, binary options attract the attention of many, especially novice investors, because of the simplicity of the operation. To start investing in binary options, it is necessary to open an account with one of the brokers. We should also keep in mind the very high risk associated with this type of investment.