What Are Binary Options and How do They Work?

Binary options are simply speculations on the performance a particular asset or index. Stocks, bonds, foreign currency, commodities and even predictions related to job growth can all be in play with these types of contracts. They are most commonly traded on digital platforms, but they can also be executed over the counter outside of traditional markets. It is important to note that buying or selling binary options does not have anything to do with the financial instrument itself, but whether or not its value will fall above or below a set price at a specific time.

Binary Options are Comparatively Simple

Binary options represent two and only two outcomes upon settlement: $0 or $100. This means that any gains or losses will fall within this range, which is beneficial for those who wish to minimize risk. However, the most anyone can walk away with is capped at less than $100 as well. Keep in mind that commissions, fees and the buy/sell price of the item being traded is also included in this range. Traders can purchase more than one contract at the same time in order to increase their payout potential.

For example, let’s say that an investor feels the price of Brent Crude will be $50.00 by 3:00 pm tomorrow. They can buy a contract that stipulates that the price will be above that amount. Other traders who are also using the same platform will collectively determine the buy price of that particular speculation which will be reflected in the value of the purchase price. The price generally parallels a probability as to the success of this outcome. If investors feel there is a high chance that oil will be above $50.00, then the price of the contract will be above high. If investors feel there is a minimal chance that oil will reach that level, then the price of the contract will be low.

Remember that all prices will be below $100. Perhaps the speculation is trading at $60.00, which is how much the buyer will have to pay to purchase the contract. If the buy price climbs to $95.00, the investor can opt to exit the contract early and keep the profits, or they can keep it open until expiry if they feel that the price will not drop below the value of their initial investment. If the price of oil is above $50.00 at expiry, and the buy price on the market remains at $95.00, then the investor is “in the money” and their return will be $35.00 in addition to getting their $60.00 back.

If the price of the contract is $75.00 at closing, then the investor will see a profit of $15.00. If the price of oil is $49.95 at closing, the investor will lose the $60.00 they used to purchase the contract. If the price of oil closes at exactly $50.00, then the investor gains nothing but loses nothing as well. Remember that contracts are not priced based on the current value of oil, rather by what the market senses will happen to the price of oil at closing time.

Benefits and Drawbacks

One of the biggest benefits of trading binary options is that investors don’t need a lot of funding to get in the market. Most trading platforms require a minimum deposit of around $200 or less, and there must be enough money in the investor’s account before the contract will be executed. The money for a particular trade will be automatically deducted until the contract expires or is settled. If the gains favor the investor, the returns, along with the initial investment will usually be immediately re-deposited into their account (less fees and commissions).

One of the biggest drawbacks to trading binary options is that many platforms and brokers are not regulated and are based outside of the United States. There are a couple of trading services that are regulated in the United States, and a number of overseas operations are regulated in Cyprus or the EU. An increase in complaints to the SEC regarding fraud over the past few years has led to a warning being issued for investors to be careful. It is up to the investor to perform due diligence to ensure they are trading through a reputable source.

Summary

Binary options are a very easy way to play the market without actually being in the market and making large investments. There are literally hundreds of options to choose from, and day traders as well as longer-term investors can benefit from this system. However, markets can be volatile, and the lack of uniform regulation or accountability enhances risk. Working with a reliable broker or platform will reduce the likelihood of encountering fraudulent activity and ensure that traders are engaged on a level playing field.

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  1. Peggy Francoeur
  2. Anissa Clarke

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