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What Are Binary Options and How To Make Money Trading Binary Options

Updated on January 5, 2017

Learn About Binary Options

Binary Options Provide "All or Nothing" Payouts Depending Upon Whether The Option's Target Price Has Been Met at Expiration
Binary Options Provide "All or Nothing" Payouts Depending Upon Whether The Option's Target Price Has Been Met at Expiration | Source

What Are Binary Options? | An Explanation

What are binary options? Binary options provide traders a way to bet on the direction that various financial products will trade within a specified period of time, which could include a time limit of hours, days, or weeks. The financial products that binary options are written against include specific stocks, exchange traded funds (ETFs), stock market indexes, currencies, and commodities. If a trader buys a binary option, it will pay a predetermined limited payout, if the price of the financial product that the option is written against is exceeded either to upside for a long binary options bet or the downside for a short binary options bet. A binary option expires worthless if the option’s target price is not exceeded when the option reaches its expiration time.

Binary options are also known as “all or nothing options,” since they either pay their full pre-determined amount or they pay nothing at all, depending upon the price of the underlying financial product upon option expiration. Traditional options, which are the other kinds of options that can be traded, pay out at various levels if the price of the underlying financial product exceeds the option’s target price upon option expiration. Traditional options have much greater reward potential than binary options, but are also more difficult to trade and harder to understand.

While many individual investors have trouble understanding the often complicated options trading strategies that professional traders use when trading traditional options, binary options offer a simple way to place a bet on the movement of stocks and other financial products. A binary option either exceeds the target price at the end of the specified expiration time that the binary option is written for and pay the amount advertised or it does not reach the target price and expires worthless.

The casino game craps provides a good example regarding how binary options work. While craps has a myriad of complicated bets that many inexperienced players do not fully understand, one can place a simple bet that the thrower of the dice will either succeed “pass” or not succeed “no pass”. Binary options operate in the same manner. A binary options buyer is betting that a financial product will succeed at reaching a target price before the expiration date and time.

How Binary Options Are Traded and How Money Is Made Trading Them

To understand the answer to the question “What Are Binary Options?” take a look at an example of a binary options trade.

If a trader expects Apple Inc’s stock (AAPL) to close above $500 per share at the end of a trading session because Apple has a new iPhone product rollout during the afternoon, they might buy ten binary cash call options to try to make money on an anticipated price spike in AAPL above $500 per share. The ten binary cash call options would have a strike price of at $500 at the end of the regular trading session, with a hypothetical payout of $100 on each option, if the strike price is exceeded at the time of option expiration. The ten binary cash call options would hypothetically cost $30 each, or a total of $300 to establish the binary options trade.

If AAPL closes at the end regular trading below the $500 per share strike price, the ten binary cash call options would expire worthless, and the purchaser of the options would lose the $300 that was spent buying the options. If AAPL closes at the end of regular trading above the $500 per share strike price, the ten binary cash call options would pay $100 each, or a total of $1,000, which would result in a net gain of $700 (minus any commissions paid) for the purchaser of the options ($1,000 payout minus the $300 spent purchasing the binary options). This binary option trade could also be made on the short side by purchasing binary cash put options on AAPL’s stock, if one believes AAPL’s price will close below $500 per share at the end of the regular trading session.

Binary options are essentially short-term bets on the closing price of various financial products that provide specific payouts, if the strike price is exceed at the time of option expiration. Some traders prefer binary options over traditional options because the amount of money that can be made from a binary options trade can be quantified when the options are purchased. Binary options either pay a specified amount or they don’t, based on the underlying financial product’s price at the time of options expiration, whereas traditional options could have a range of profit amounts, depending upon the price of the underlying financial products at the time of options expiration.

An Example of a Binary Options Trading Screen

This is what it looks like when a Binary Options trade is initiated.  The Binary Option is tracked until expiration.
This is what it looks like when a Binary Options trade is initiated. The Binary Option is tracked until expiration. | Source

A Word of Warning Regarding Binary Options Trading Websites

It is important for individual investors to understand that there are many different binary options trading websites that facilitate trading in binary options online. The websites offer a wide variety of binary option products and various payout percentages, if the options reach their target price. They also have a variety of trading rules that differ from site to site. Not all binary options websites are located within the country one resides in and not all of the sites are overseen by financial regulators. Therefore, it is important to read the fine print and understand the products and payouts available at the various binary options trading websites prior to proceeding with trading. To avoid problems, it is a good idea to only do business with reputable, established binary options trading websites that are domiciled within the country in which you live.

Disclaimer: This article was not written by a financial professional or a registered financial advisor. This article is for informational purposes only, and is not intended to be solicitation or recommendation to binary options or any financial products. Please consult a registered financial advisor to ensure you understand the risks and rewards associated with buying and selling binary options and other financial products.

Binary Options | Example of successful trading in binary options

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Comments

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    • Jack Knorler profile image

      Jack Knorler 2 years ago

      Gambling = Probability + Skills. So if you have some trading skills i would say that you have more probabilities to win.

      There are also softwares and signal that can predict.

    • Rock_nj profile image
      Author

      John Coviello 2 years ago from New Jersey

      aesta1 - Please keep in mind that binary options and regular put/call options are two different animals. Binary options have more of a gambling aspect to them, as you are betting that either one of two outcomes will be achieved. Regular put/call options can be used to leverage or protect stock positions. Read up on options as much as possible. A good idea is to paper trade when investing or trading in a new financial area. Just keep a log of the trades you would make (without committing any money) and see how they work out.

    • aesta1 profile image

      Mary Norton 2 years ago from Ontario, Canada

      I am seriously studying options trading now to enhance my investment. This binary trading when supported by good research seem to be a winner. It still scares me though.

    • Rasimo profile image

      Rasimo 4 years ago

      It's very interesting, thank you for sharing

    • Rock_nj profile image
      Author

      John Coviello 4 years ago from New Jersey

      Hi Andera, Binary options have a lot more in common with gambling than investing. I wouldn't call them a form of investing either. But, they certainly can be used to make quick money by betting on which direction financial products will move in the short term.

      People that don't understand what makes stocks and other financial products move could get burned trading binary options. For example, it is common for stocks to sell-off after a big news announcement, if it is already widely anticipated, such as a new iPhone release. That's called "sell on the news". If one is using binary options to bet AAPL will surge higher with a new iPhone release, they may be sorely disappointed when stock traders sell their AAPL positions after the news and send the price of AAPL share lower. Stocks generally surge higher when news is positive and unexpected, or expected and much better than anticipated. Otherwise, look out for the downdraft....

    • Andera profile image

      Andera 4 years ago

      Binary options seems like an exciting way of betting on stock market prices without any underlying strategy. I would hardly call it a form of "investing", but I see how people could be drawn to it.

    • mylindaelliott profile image

      mylindaelliott 4 years ago from Louisiana

      It sounds interesting but even so too complicated for me.

    • Rock_nj profile image
      Author

      John Coviello 4 years ago from New Jersey

      Thanks for commenting Eric. I used the casino game "Craps" as an example of binary options trading for that very reason. Binary options trading is gambling pure and simple. There's not much more to it. You place a bet and win or lose based on the closing price of the financial product the bet is placed upon. Regular options actually have other functions besides gambling, such as leveraging a trading position or conversely protecting a trading position.

    • Ericdierker profile image

      Eric Dierker 4 years ago from Spring Valley, CA. U.S.A.

      Sounds like a lot of fun. Clearly this is one where if you do not have it to lose do something else.

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