A binary option is an option with only two possible outcomes: you either gain a fixed amount (or fixed asset) or lose money. You can never lose any more money than what you paid for the binary option. This is one of the things that makes binary options appealing to many – you know exactly how much you risk losing and you also know exactly how much you will gain if you don’t lose. With stocks for instance, there is a sliding scale where you might gain $0,50 or $50 or $500 during a certain period of time. This is not the case with binary options.
When you purchase a binary option, your task is to predict the outcome of a binary situation.
Example: Will the price of a Company NNN share be worth more than $12.00 at 10:00 EST today?
If your prediction turns out to be correct, you receive the predetermined amount of cash or the predetermined asset (e.g. a share in Company NNN). If your prediction is wrong, you lose your money.
It should be noted that there are some binary option sites where you don’t lose all your money even if your prediction is wrong. Example: You purchase a binary option for $200. If you’re right in your prediction, you get $1,500. If you are wrong in your prediction, you get $30.
Binary options are sometimes referred to as investments, but they tend to be too short-term to really qualify as investments in the traditional sense of the word. Earning money from binary options is more similar to day trading or other types of short-term speculation than actually investing and holding long-term positions.
One of the major appeals with binary options is that they often offer a high potential reward for a small mount of money down.
One of the most popular brokers of binary options is IG Index. They only offer a small selection of binary options but remains a favorite among experienced and novice traders alike due to their very high return rates. Regular binary options give you a 96% return when trading with IG Index. You can read more about IG Index by visiting BinaryOptions.co.uk.
Binary options are marketed under several different names, including:
Binary options connected to the forex market are, for unclear reasons, often referred to as digital options.
A cash-or-nothing is a type of binary option where the reward for being right is cash. This is contracted by the asset-or-nothing binary option where the reward for being right is not cash but some other type of asset, e.g. a share.
At 08:30 in the morning (EST), you purchase a cash-or-nothing binary option for €50 stating that you will get €1,500 if the price for a share in Company BBB is over $12 at 09:00 EST.
At 09:00 EST the price for a share in Company BBB is $14 and you get your €1,500. If the share price had been $12 or less, you would have lost your €50 because the option itself is worthless once it has expired.
At 08:30 in the morning (EST), you purchase an asset-or-nothing binary option for €50 stating that you will get 100 shares in Company BBB if the price for a share in Company BBB is over $12 at 09:00 EST.
At 09:00 EST the price for a share in Company BBB is $14 and you get your 100 shares in Company B. If the share price had been $12 or less, you would not have gotten any shares. You would have made a €50 loss because the option itself is worthless once it expires.
If you make a profit or not from your 100 shares in Company BBB depends on their sales price when you sell them. (Unless they pay dividends, in which cases any dividend payments must be entered into the equation when determining if the transaction was profitable or not.)
It was only quite recently that exchanges started trading in binary options.
In 2007, the clearinghouse Options Clearing Corporation (OCC) in Chicago proposed a rule change that would allow binary options. The following year, the Securities and Exchange Commission in the United States made it legal for exchanges in the U.S. to list cash-or-nothing binary options.
Two of the pioneers were the American Stock Exchange (now NYSE MKT LLC) who began listing European cash-or-nothing binary options in May 2008 and the Chicago Board Options Exchange who followed int suit in June. Today, they both offer binary options with a value of $0 – $1 and a multiplier of 100. The tick size is $0.01 and all binary options are cash settled. The binary options are always on highly liquid equities or indexes, e.g. S&P 500 and the CBOE Volatility Index (VIX).
Exchange-traded binary options are standardized and exchange-traded with continuous quotations.