Binary options basics
Binary means two parts, Binary options trading is so called because its contracts always result in only two types of outcomes: the investor either gains money which is referred to as ‘in –the –money’ or he gains nothing also referred to as ‘out-of-the-money’. Binary options basics are based on two simple betting options –the call option and the put option. A trader wishing to trade in binary options needs to do the following things.
- Predict after careful analysis of all the factors influencing the stock price, the possible direction that the cost of the underlying asset will take within a predetermined expiry time frame as mentioned on the contract which might range from a few hours to a month.
- Purchase a contract by paying a ‘premium’, based on the predictions about the stock’s performance within the expiry date.
- Choose ‘call option’ indicating that he predicts the stock to rise above a given value called the ‘strike value’ or choose a ‘put option’ if he favours a decrease in the stock price; within the expiry date.
Another component of the binary option basics is the FROs or the fixed return options which means the payoff is fixed before the trading begins, and the trader receives fixed amount according to the percentage set in the contact. To help understand the binary options basics, let’s visualise a hypothetical situation where the trader bets on an X company’s stock price in the market. The trader may believe that the stock price will increase in the next one hour above the current stock price.
Based on this prediction he invest $100 as ‘premium’ in purchasing a binary options contract that pays 70% return on the initial investment at the end of the hour. If the prediction is successful then the buyer stands to gain $70 plus the initial $100 investment at the end of the hour; a total of $170. If the transactions fail to succeed then the trader gets less than 10% of the returns or nothing in which case he loses his premium.
The Binary trading system also goes by the name of digitalised trading options or exotic options trading, offering a range of assets that can be traded for such as currencies, commodities and stocks using a variety of options like cash or nothing, asset or nothing and touch options.