Thursday, July 24th, 2014

How Do Binary Options Work?

 

A binary option is a somewhat simplified version of options trading. How to binary options work? In trading either American or European style standard options a trader purchases the right to either buy or sell 100 shares of a stock, which he will do if the stock price moves as he anticipates. He is under no obligation to buy or sell and is only risking the premium he pays for the opportunity. In American style options the trader can execute the options contract at any time up until expiration. In European style options trading the trader can only execute the contract upon expiration. In each case the trader who exercises an options contract will be buying or selling the hundred shares of stock in question. In the case of a binary option a trader who correctly anticipates stock price movement will receive a cash settlement, not stock. How do binary options work if you wish to buy one? How to buy stock options is the same for each type of option. The trader will go online or directly through a broker and purchase the option. How do binary options work as regards the reward for successfully anticipating stock price movement? Not always so well, as for a well planned and executed call or put option, on a stock that moves substantially in price.

When to buy puts, and when to buy calls, are the same in binary options trading as in trading regular options. The difference is in the potential profit. How do binary options work regarding profits? This depends on the kind of binary option. Binary options come to two varieties. There are cash or nothing binary options and asset or nothing binary options. In the case of a call option, a cash or nothing binary option pays a fixed amount of cash if the terms of the contract are satisfied. An asset or nothing binary option pays the price of the stock if the terms of the contract are satisfied. If the stock has moved up substantially in price the asset or nothing option more closely approximates a standard option in that the payout is better. The limiting factor of this situation is that the individual does not receive the option to purchase stock, which is what a call option allows in standard options trading. If the stock price moves above the strike price, the option is then in the money and executing the trade will be profitable. However, if the stock moves substantially higher the trade will be extremely profitable. In the case of cash or nothing binary options the individual receives the same amount no matter how high the stock rises. Only in asset or nothing binary options does the individual receive the price of the stock as payment. However, the standard options trader may choose to hold on to the stock to see if it goes higher. This is not possible in binary options trading, even in asset or nothing contracts, because the individual receives cash and never sees a share of stock.

How do binary options work as far as profits? In each general class of options trading, profits come from accurate reading of how a stock price will progress in the market. How do binary options work as far as investment risk is concerned? If the individual is buying call options the situation is similar in both classes of options trading as the only loss is the price of the premium paid to purchase the option in the first place. How to trade options, standard or binary, will depend upon how involved the trader wishes to be in the market. Binary options are somewhat limited compared to standard options, but for many investors less complication may be more attractive.

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