Binary Options are a booming segment of the online retail investment industry because they offer access to a wide range of securities that are traded on world markets with very low capital requirements. Read the brief overview below to find out what they are, how they work and get examples of such transactions.
What are Binary Options
Binary Options constitute an innovative and simple way to trade, which has several advantages over other, more traditional, investment tools.
Through Binary Options the investor is merely called to predict whether the price of an asset/investment title (index, currency, etc.) will be higher or lower at the end of a given period, irrespective of the actual amount of the change in its price.
The Binary contract proves profitable, if at the end of the specified time period (which usually ranges from a few minutes to several hours), the prediction of the investor about whether the price will move up or down from the opening price is right.
If the prediction is correct, i.e. it expires “In the money”, the profit is then calculated based on a predetermined percentage yield, known from the beginning of the “life cycle” of the specific contract. If the market moves contrary to the prediction of the investor, then the contract is said to expire «Out of the money», and he thus loses the entire investment amount.
The reasoning that characterizes and underlies the operation of Binary Options is summarized in the phrase “all or nothing” and it much resembles the functioning of the “Under / Over” sports betting type, as the player chooses between two possible outcomes, i.e. a rise or fall of the market.
Types of Binary Options
The best-known Binary Options are the “high / low fixed price», in which the investor is asked to determine whether the price of the underlying asset will be higher or lower than the current price at the end of a predetermined time period.
In the single fulfillment binary options type, known as “One Touch,” it is enough for the title value to “touch” a predetermined price threshold (an upper or a lower price target) at least once by the end of the specific Binary contract, for it to be deemed as profitable.
In the Binary Range type of contract, the investor is asked to predict whether the price of the underlying asset will be within a range of values at the end of the contract.
Example of trading Binary Options
The trader believes that in four hours the price of gold will be higher than the current price, but without being able to predict how much higher. To trade on this belief, in the Binary Options platform that he has an account with, he selects the purchase contract «Call», the time for product maturity (4 hours) and the amount he wants to risk (eg. 100 €). Suppose that the yield of this specific trade is preset to 80%.
If in 4 hours, the time of expiration of the contract, the price of gold has risen from the current price (no matter how much more), the investor will receive 180 euros (100 euros from the initial investment plus 80 euro net profit from the yield of 80%).
If, however, the price of gold in 4 hours is below the current price, then the investor loses the entire amount of the investment.
In the same manner, in Binary Options contracts where investors predict a fall in the price of an asset, they have to choose the contracts Sale option («Put»). The said contract will expire “in the money” if the market price falls or “out of the money” if the market price rises.
On some platforms, the investor has the ability to “close” the Binary Option contract prematurely, before its expiration. In this case, the yields obtained will vary according to the movement of the market.
Advantages of Binary Options
Binary Options offer access to a wide range of securities that are traded on world markets (indices, currencies, equities, commodities) with low capital requirements, thus opening up lucrative opportunities to people who are not institutional investors and have little disposable income to trade on.
The function of Binary Options is very simple, since they require the investor to predict whether a particular title will demonstrate a rise or fall in its price in a specified period of time, no matter what the exact change is or the course of the price in the intermediate period.
Moreover, Binary Options are ideal for intra-day transactions, also known as day trading, they do not burden investors with the physical possession of the underlying instrument and they allow risk management through hedging in open stock positions.
The potential rate of profit for a binary options contract is clearly defined at the opening of the transaction and it can reach 100%. Known is also the risk assumed by the investor if the prediction is wrong and this risk is limited to the predetermined initial amount of the transaction.
Due to the short duration of Binary Options contracts, interested investors are advised to show restraint in regard to the number of transactions they enter into at any one time, in order to avoid quick “dips” in the size of their account and undesirable psychological pressure.
It is believed that the increased interest of investors for Binary Options and the intense competition among brokerages to offer them, will cause in the next years an even stronger expansion in the sector, increasing the range of options offered ( in terms of duration, increased yields, assets offered etc.).