What Are Binary Options?
What are Binary Option
Binary options trading, also known as Digital Options, Fixed Return Options (FRO), asks the trader a very simple question: Will an asset go up or down within a set time period? In other words, a binary option is a type of trading where the trader takes a yes or no position on the price of a financial asset, and the resulting payoff is all or nothing. Because of this characteristic, binary options can be easier to understand than traditional trading.
Unlike traditional options, where the payout is based on the price of the option at expiry and each increment that the asset continues to rise or fall can have a huge impact, binary options are all or nothing, where correctly predicting the direction is all that matters. There are only two possible outcomes with binary options – either you predict correctly and win, or you lose.
Despite the term “all or nothing,” depending on the actual trading platform, “nothing” can actually mean “something.” This means that at expiration the owner of the option may actually get a certain payout even if the option expired “out of the money”.
How does it work?
A binary option trade on many broker’s platform may look something like this:
An investor purchases a Microsoft binary option for $100, with the opinion that at the end of the day Microsoft’s shares will be higher than they currently stand. If he is correct then we offer a 71% return on his investment.
1 – If at the end of the day, Microsoft is indeed higher than at the time the option was purchased, then broker will pay the investor a $171 payout
0 – Should the shares be lower, then broker will refund the investor $15
This means that when the contract is purchased, the investor knows that he will receive either $171 or $15. These values will obviously be much greater, the larger the investment. A Binary Option broker investment of $1,000 with a 71% payout will result in a $1,710 payout or a $150 refund.
Pros and cons of binary options
Here are some of the pros and cons of trading binary options below. For every reason to get into the market, there’s a potential downside to keep in mind. Knowing about them in advance will help you plan your trading strategy while staying in control of the typical new-trader jitters.
- Quick Payoff: There is a potential for a quick payoff. Where else can you get a 70% or more return on your capital in hours, if not minutes? Payoffs can actually be higher, and there is always a possibility for a rebate percentage amount if you guess wrong. Many brokers also offer special weekly “one-touch” options with astronomical payoffs in the 500% range.
- Simplicity: Trading binary options is drop-dead simple. Choose an asset, pick a contract, enter the amount you want to invest, and execute. The trade expires within minutes – or in the case of 60-second binary options, literally seconds. Does it pay to do some quick analysis before executing trades? Sure, but your analysis will probably be limited to looking at candlestick charts and plotting pivot points. Both are easy once you get the hang of it.
- Low Risk Of Substantial Loss: Although there is considerable risk associated with trading binary options, the amount of money at risk is entirely in your control. The contracts you trade won’t pull your bankroll through the floor, generating margin calls and panic attacks. You’ll know your potential loss upfront because you’re the one who decides how much money to put into any given trade. Keep in mind that some brokers, such as TradeRush (click here for our TradeRush review), will let you place trades for as little as $5. The main thing to remember is that you don’t have to risk thousands of dollars unless you want to. If you prefer, you can place trades for the same amount you’d pay for a large iced mocha at Starbucks. Of course it’s hard to make a living trading binary options when you’re placing $5 trades, but you at least have the option.
- Unbalanced Risk to Reward Percentage Ratio: for a common payoff ratio of 70%, including a 15% rebate feature, a trader must still win 55% of the time to break even, let alone record a gain. This situation is often referred to as a “negative reward/risk proposition”. Your odds are better at a roulette table. The added “cost” pays for commissions, the simplicity of the investing format, and the limiting of risk exposures.
- High payoffs mean high risk: Short timeframes also mean that consistent predictions of market movements will be harder to come by.
- Limited demo testing capabilities: Note that this doesn’t apply to every binary options broker—just the majority. If you were going to trade Forex, you’d find that many brokers give you a demo platform you can use indefinitely. Most binary options brokers seem to skip this altogether, or only provide you with a demo platform you can use for a few days or a few trades. There are a few brokers with less restrictive demo platforms however such as Banc De Binary and MarketsWorld.
- Poor regulation: Right now so many binary options brokers are unregulated. In other types of trading (Forex for example), regulation is the norm. This makes it more challenging to find a trustworthy broker. We have a few good starting recommendations however, and strive to only list brokers with a legit history and reputation.
Go With Legit Brokers
One of the biggest cons to trading binary options is that the fairly short history of online brokers is one filled with story after story of a shady brokers scamming people out of their money. The simplicity of binary options trading is attractive to scammers looking to take advantage of peoples want to find that easy way to make money. The truth of the matter is there is not a simple solution and even though binary options are simple to trade, they are not easy! Use a broker that you trust and that is trusted by other traders. Use common sense and do not go crazy investing money you can not afford to lose. If you are trying to make quick cash to pay the bills, binary options is not it. If you are looking to find the right trades, understand the risk and are ready to take some shots, then sign up at a legit broker (see http://www.brokerviewer.com/binary-options-brokers/) for our current top choices of where to trade.
The bottom Line
In a nutshell, binary options trading offers a high payoff potential with risk fixed on the front end. The best advice is to invest considerable time practicing on a free “demo” system before risking your hard-earned capital. Everyone may not be cut out for this fast-paced trading environment. Let caution be your guide!