Today, an increasing number of people around the world are trading in binary options, trying to capitalize on the high return on investment that this straightforward concept provides. The good news is that you need zero trading experience as all you have to do is speculate whether the asset will go up or down, placing a call or a put option in your trade, depending on the direction of the market.
What are binary options?
Binary options are investment vehicles that allow you to trade on price fluctuations of underlying assets and basically predict whether the asset’s price will rise or fall within a specific time frame. Although they provide access to stocks, indices, commodities and foreign exchange like traditional options, binaries differ in their liquidity structure and investment process. When investing in binary options you take into consideration the direction of the market and you predict whether the option will rise or fall up to the expiration date. If at expiry, your prediction in on the right side of the strike price, i.e. the price that you can exercise your option, you get a fixed payoff. If at expiry, your prediction is wrong, you lose your initial investment.
Calls and Puts
Calls and puts are the two options you have to enter a contract in which you have the right to buy an underlying asset at the strike price within a fixed period of time until expiration. The difference between the two is your belief about the market’s direction. If you believe that the market is rising, you will purchase a call option. For the call option to provide you with a fixed payoff, the market price (S) has to be higher than the strike price (K) at expiry. In contrast, if you believe that the market is on a downward trend, you will purchase a put option. For the put option to be profitable, the market price (S) has to be lower than the strike price (K) at expiry.
There is a major upside in trading binary options. This is that the risk and reward are known. If the market moves in favor of your prediction, you earn a fixed amount. If not, you lose a fixed amount. You are free to decide how much you want to invest in the underlying asset as there is no fixed price, just fixed return. For instance, do you believe that the price of an asset will move up within the next minute? You can invest in your forecast and make up to 90% profit on your investment in a minute. Also, compared to traditional options, binary options have no fees, especially if you choose the right online trading platform. Finally, you don’t have to deal with liquidity concerns as you don’t actually own the underlying asset, you simply predict if it will go up or down. Online trading platforms like 10trade can offer a range of strike prices and expiration dates for underlying assets that can be traded in global markets 24/7.
How to read the signals
Suppose Microsoft (MSFT) is at $250 a share and you believe it will rise above $300 this week. You could buy 5 MSFT binary options for $0.20, which will make 5 contracts x $0.20 x 100 (multiplier) = $100. If MSFT closes at $300 or higher within a week (which is your expiration date), you will make a profit of $300 – $100 = $200. You don’t care if it will close at $300 or $350 as long as it closes higher than the strike price of $100. Otherwise, you lose your $100.
The bid and ask are determined by investors and traders who evaluate the probability of the option outcome. For example, if the bid and ask on a binary option are at 75 and 80, respectively, it means that traders assume a very high probability that the option will expire worth $100. If the bid and ask are around 50, there is an uncertainty about the outcome. If the bid and ask are at 15 and 20, respectively, traders assume a high probability that the option outcome will be below $100 and at expiration you get $0.