How Binary Options Work
Binary options are generally traded through a dedicated online digital broker. They are an ‘over the counter’ (OTC) product whereby the deal is made directly between the trader and the broker.
No actual investment is made in the underlying asset. They provide a simple and understandable wager on the anticipated price movement of a selected underlying asset. Due to this unique way in which they operate, binary options provide several unique trading advantages.
The first of these is that they offer known limited risk. The ‘risk’ can be interpreted as the price paid for the contract at the outset. This means that your account is never exposed to any further loss than the initial price which you pay for the contract.
Contrast this with other forms of financial trading such as spot Forex or spread betting. Here you can face liabilities on your account right up until the point that your position is closed. It is of course true that you can use stop loss levels to limit any losses, however even guaranteed stop levels from your broker can be subject to slippages in fast paced markets.
With digital binary options your maximum loss will only ever be what you paid for the contract at the outset.
A second point of difference is that you earn a set profit. This means that you don’t have to call big price moves in order to make equally high profits. All you need is for the market to finish above (or below) the strike/ purchase price.
To illustrate this let’s look at a quick example of a trade. We will use a Call/Put (High/Low) binary option to show how this works in practice.
You look at the markets at 08:00 in the morning and note that Oil is showing a strong upward trend which looks set to continue. The current price is $98 per barrel.
Expecting the price to continue rising throughout the day, you place a Call Option (market to be higher than the current price) to expire on at the next hour at 09:00. You purchase a contract for $100.
Let’s assume the payout on this option is 75%.
If at the time of expiry (09:00) the Oil price is above $98 then the option is said to finish ‘in-the-money’. You make a return of 75%. The $100 you used to purchase the option is credited back to your account, together with $75 dollars profit (the 75% return on the option).
This return is gained no matter if the oil price had risen to $99 or $105. In fact it could have finished just 1 cent up from the level that you placed at.
As long as the price is higher than the strike price that you purchase the option for you will still earn the high return for your market call.
So you see, you don’t have to call big moves in order to make high profits. You can still make exceptional returns even in slow moving markets and over short time periods.
Placing A Contract
Digital binary contracts are placed with a Binary Options brokerage. These companies deal exclusively with digital binaries and offer contracts on a range of the major financial asset classes.
Trading is conducted online through a dedicated web based trading platform. From here an increasing number of different types of contracts can be placed which allow for different price outcomes to be profited from. These include the Call/Put, Boundary and Touch digital contracts.
Contracts can be placed to run for different time periods with common expiry times being hourly, daily or weekly. In the case of some brokers you can even trade with much shorter contracts which last for just over 60 seconds.
It doesn’t matter what contract you place or on which asset. The same basic principles of fixed profits and controlled risk will still apply.