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The Risks Of Binary Options

Updated on August 27, 2012

Binary Options Are Gaining Popularity

Binary options are an attractive and risky way for short term traders to enter the market.
Binary options are an attractive and risky way for short term traders to enter the market. | Source

What Are Binary Options?

Binary options have always been around. They offer a simple way for investors and traders to bet on the market. They are also commonly known as fixed return and all-or-nothing options. They are different than the standard, American style, options that are traded through US based and regulated brokerages like OptionsXpress, Ameritrade and E-Trade.

Binary options are not the same as a standard option. For the most part binary options are strictly cash vehicles and do not correspond with an underlying stock. What this means is that a binary option on Oracle does not get you 100 shares of Oracle stock, it only gets you the pre-agreed profit or loss. Some binary options do have underlying value. These are usually forex or commodity based binary options. In those cases excercising the option would result in delivery of 100 Euros or 100 bales of cotton.

Trading binary options is the closest thing to pure gambling the stock market has to offer. The practice reminds me of the book "Remeniscences of a Stock Operator". Especially the parts about the bucket shops. In the bucket shops stock operators and common folk alike were allowed to speculate on the direction of market movement. Their "investments" were only good for a few minutes or hours and as the day progressed quickly lost value. Binary options are the same. They can have expirations of hours or minutes and are only concerned if the stock closes in or out of the money.

Binary options have risen in popularity because the industry is unregulated. It operates on the internet, across international borders, 24 hours a day. Accounts are made with internet companies whose business it is to provide a community of buyers or sellers. Forex traders began to move to binary options markets when the regulations in that market began to tighten here in the US. Binary options gave them the opportunity to trade foreign exchange pairs in nearly the same way the are on the forex markets but with little or no oversight.

How to Trade Binary Options

Trading binary options is simple. There are dozens of highly rated binary options trading sites on the internet. One prominent site is TradeRush, another is After opening an account trading is as simple as choosing a stock and whether or not it will go up or down before the close. If you think the stock is going up buy a call and if you think it is going down buy a put. At the time I was writing this traders were speculating on whether or not Apple would be over or under $575 before 2:00 pm eastern time.

Can You Make Money With Binary Options?

FTSE 100
S&P 500
Dow Jones 30
FTSE 100
Total gain
Total Loss

Results based on $100 trades. Results will vary. Based on these 12 trades it would take two winning trades to bring the account to a positive balance of +$47. If risk management could be employed so that each trade stopped out at $30 instead of $15

The Risks Of Binary Trading

  • No risk management. You can not place stop loss or profit taking stops on your trades. One you buy them you are in and will either win or lose. No in between.
  • Spread. You must take the spread into account. There may be a more appropriate industry term for this but what I mean is the difference between the price of the stock and the level of the option you buy. The more time you buy the bigger the spread. This spread is the market makers tool to mitigate his risk in order to make money, much the same as the equity options market maker does with the bid/ask spread and implied volatility.
  • Minus sum game. Binary options is a minus sum game. This means that the house always wins. It is possible to make money in the binary options market but it takes more skill than equity options. In equity options I know from my history that If I am at least 50% right on my trades and use my risk management system I will always come out ahead. With binary options that is not the case. For example, If you trade $100 and get a 71% return you make $71. The payout on the losing trade is $15, a loss of $85 for a net loss of $14.


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