How to Understand Binary Options

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Before I tell you how to understand binary options, there is software out there that can help you save time and make you money without you to understand any of this. Click Here! if you are interested in this software. It really helps! A Binary Option is a type of option where the payoff is all or nothing. Because of this characteristic, Binary Options can be easier to understand and trade than traditional options. Binary Options are cash-settled as European-style options, meaning they can only be exercised on the expiration date. If, at expiration, the options settle in-the-money, the buyer or seller of the options receives a pre-specified dollar amount. Similarly, if the options settle out-of-the-money, the buyer or seller of the options receives nothing. This provides a known upside (gain) or downside (loss) risk assessment. Unlike traditional options, Binary Options provide full payout due to a single pip movement. Despite the term "all or nothing", depending on the actual trading platform, "nothing" can actually mean "something". This means that at expiration time the owner of the option may actually get a certain payout amount, even if the option expired "out of the money". Very often you may encounter binary options under another name. In forex exchange market Binary Options are known under the name of digital options.

Steps

Learn the two outcome options. A trader of Binary Options needs to anticipate the expected direction of the price movement of the underlying asset. Unlike traditional options, knowing the direction of the price movement, as well as magnitude of the movement, is not required. If the investor has an opinion about an underlying asset and wants to places a trade, s/he can trade Binary Options.
Decide your position. Buy if you believe the market price will rise or the economic event will occur. Sell if you think the opposite. If your insight is correct, on the expiration date, your payoff is the settlement value of your contract.
Learn how the price is determined. The price of a Binary Option contract is equal to the probability of the event happening. For example, if the contract value has a value of $100 and the last trade of the contract was at $96.00, it is an indicator that 96% of the market believes that the event is going to happen and the contract will end up in-the-money.
Learn the advantages of trading Binary Options over Traditional Options.
- Binary Options are generally simpler to trade because they require only a sense of direction of the price movement of the underlying asset, whereas traditional options require a sense of direction as well as the magnitude of the price movement.
- Binary Options have controlled risk to reward ratio, meaning the risk and reward are pre-determined at the time the contract is acquired. Traditional options have no defined boundaries of risk and reward and therefore the gains and losses can be limitless.
- Binary Options provide nearly all the trading and hedging strategies that are possible while trading traditional options. Binary Options maintain a level of trading sophistication and functionality.
- Unlike a traditional option, the payout amount is not proportional to the amount by which the option ends up in-the-money. As long as a Binary Option settles in-the-money by even one tick (regardless of how much in-the-money it is), the winner receives the entire fixed payoff amount.
- Binary Options offer contracts with short-term durations. In some markets, Binary Options contracts close multiple times throughout the trading day, while others may last as long as a quarter. This provides the trader with several investment opportunities and flexibility as markets change over time.
Learn where binary options are traded. Binary Options have been enormously popular in Europe and are extensively traded in major European exchanges, like EUREX. In the United States, there are a few places where Binary Options can be traded. The Chicago Board of Trade (CBOT) offers Binary Options trading on the Target Fed Funds Rate. To trade these contracts, traders must be members of the exchange or investors are required to trade through such members to execute a trade - the value of each contract is $1000.
Check the implicit transaction costs of a binary option. By way of comparison, a commission of only a few dollars to buy thousands of dollars' worth of a stock and another few dollars to sell it costs only a fraction of a percentage point in returns that you would have to make up for in skill to break even. What percentage of the time would you have to be correct to profit from the binary option you are contemplating? How different are the terms (for instance, "strike price") for one side of the trade you are contemplating and the other side (or, more precisely, its reverse)? If they are far apart, one would have to successfully predict that the underlying assets would move far from what the option-sellers predict--generally something between the terms offered for different sides of a transaction--which would be unusual to occur. It is extremely rare and difficult to out-guess the market consistently, so high transaction costs can easily hurt or eliminate returns.

Tips

Know how to interpret a Binary Option price - The price at which a Binary Option is trading is an indicator of the chances of the contract ending in-the-money or out-of-the-money.
Understand the relationship between risk and reward - Risk and reward go hand-in-hand in binary option trading. The more the risk or unlikelihood of a particular outcome occurring, the greater the reward associated with it. An intelligent investor understands and weighs each contract on these two matrices before taking a position in a contract. As an example, an investor who follows foreign currency movements senses that the USD is gaining ground against the YEN and wants to hedge his risk and try to protect his Japanese investment from dropping in value. He may do this by buying 10,000 binary contracts on HedgeStreet, which are “USD/YEN rate will be above 119.50” by 4:00 PM ET tomorrow. If his analysis is correct and the USD gains ground over the Yen, rising above 119.50, the 10,000 binary contracts will expire in-the-money, yielding a total payout of $1,000,000. If he paid $75 per contract, he will make $25 per contract, which is a $250,000 total profit - a 33% rate of return on his investment. However, if the Yen did not end above 119.50, the 10,000 binary contracts will expire out-of-the-money. In this case, the trader would lose his initial investment on the binaries, but would be compensated by the gain in value in his Japanese investments.
Know when to get out of a position - An intuitive trader acts promptly when he feels that his binary contract is going to end out-of-the-money at expiration. Example: You have a $75.00 Silver contract that you feel is not going to expire in-of-the-money. Instead of holding it until expiry, selling it at $30.00 and neutralizing your open interest will help you manage the loss (i.e. $45.00 instead of $75.00).
Know the underlying asset - Binary Options derive their financial value from underlying assets.Before investing in a Binary Options, make sure you understand the underlying asset, are familiar with the relevant financial markets and where the asset is traded. Example: Silver Futures are listed on NYMEX/COMEX.

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Friday, January 17, 2014