Binary options are similar to traditional options in many ways except that they ultimately boil down to a basic yes or no question. Instead of worrying about what exact price an underlying stock is going to have, a binary option only cares if it is going to be above one price at the time of its expiration. Traders then make their trades based on if they believe the answer is yes or no. While it may seem simple on its face, it is important that you fully understand how binary options work, as well as the time frames and markets they work with. It is also important to understand the specific advantages and disadvantages that they have and which companies are legally allowed to offer binary options for trade.
If you are currently considering trading in binary options, then it is also important to be aware that binary options trading outside of the US has a different structure. Also, when hedging or speculating, it is important to keep in mind that doing so is considered an exotic options trade, so the rules are different still. Regardless, the price of binary options is always going to be somewhere between $0 and $100, it is also going to come with a bid price as well as an asking price, just like any other type of option.
They are also a great way for those who are interested in day-trading but do not have the serious capital required to get off the ground, to ply their trade. Traditional stock day trading limits do not apply to binary options, so you are allowed to start trading with just 1, $100 deposit. It is also important to keep in mind that binary options are a derivative created by their association with an underlying asset which means they do not give you ownership of that asset in any way. This means you cannot exercise them to generate dividends or enact voting rights as you would with standard options.
As an example, assume you are considering purchasing a binary option that states that the price of gold will be greater than $1,250 by $1:30 pm. If you believe the scenario is going to come true, then you would want to buy into the option. Otherwise, you would want to sell it.
Further assume that the option is trading at a bid price of $42.50 and an ask price of $44.50, 30 minutes before it is set to expire. If you buy into the binary option at this point, you will pay $44.50. Otherwise, you would pay $42.50 to sell it.
If you buy in at $44.50 and then by 1:30 the price of gold is above $1,250, then your option would expire successfully and become worth $100. You would make a profit of $55.50 before fees are taken into account. If the price ends up lower than $1,250, then the option becomes worth $0, and you lose out on your $44.50. The offer and bid prices are going to continue to fluctuate until the option expires, but you can close your position whenever you like, just as with other types of options.
Sooner or later, every option is either going to be worth $100 or be worth $0. The bid price and the asking price are set as the traders who are considering the trade determine the likelihood of success. The higher the bid and ask price are, the greater the overall perceived likelihood of the option coming true. If they are near 50, then the odds are average, and if they are very low then they are not skewed in favor of the average at all.
Where to trade binary options:
Binary options are now traded on the Nadex exchange, the original exchange dedicated to legally selling binary options in the US. It offers browser-based trading via its own platform which offers real-time charts as well as market access to the latest binary options prices.
Binary options can also be traded via the Chicago Board Options Exchange (CBOE). It can be accessed with a brokerage account that is approved for options trading via their standard access routes. It is important to keep in mind, however, that not all brokers are equipped to offer options trading. As such, before you get started trading in options it is important that you make sure your broker offers all the trading possibilities that you may one day consider as changing horses mid-stream can be quite complicated.
Trading on the Nadex costs 90 cents when entering a trade and the same when exiting from one. The fee is capped at $9 per trade so purchasing a lot of 15 will still only cost $9. If you hold your trade until it expires then the fees will be taken out at that point. If the trade ends up being out of the money when it expires you will not be charged a fee. Trading via CBOE is handled through specific options brokers who charge a variety of different commission fees.
Choosing a binary market:
You are free to trade in multiple classes of assets with binary options. Nadex allows for trading in all of the major indices including the Dow 30, Russell 2000, the Nasdaq 100, and the S&P 500. Global indices including those from Japan, Germany, and the UK are also available. Trades are also available for a variety of forex pairs including AUD/JPY, EUR/GBP, USD/CHF, GBP/JPY, USD/CAD, AUD/USD, EUR/JPY, USD/JPY, GBP/UDS, AND EUR/USD.
Additionally, Nadex also offers to trade in commodity binary options including soybeans, corn, copper, silver, gold, natural gas, and crude oil. You are also provided with the option to trading based on specific news events. You can buy options based on whether the Federal Reserve is going to decrease or increase the rates of things like joblessness claims or whether or not the number of nonfarm payrolls is going to beat its estimates or not.
The BVOE offers a smaller variance of binary options to choose from that are not currently available anywhere else. There you can buy binary options based on their own interpretation of the current state of the S&P 500 and a volatility option index based on its own volatility index.
Risk and reward:
Binary options risk is capped at the cost of the initial trade as the worst thing that will ever happen is that your option expires at 0. The risk is also capped, though it can still offer up significant returns depending on the amount of the initial investment. For example, if you purchase a binary option for $20, that ends up paying out, then you will still make $100 off of it ($80 profit) which means you have a 4:1 reward ratio which is more than you could find if you invested in the related stock directly.
This only works out in your favor to a point, however, as your gains will always top out at $100, no matter how much movement the underlying stock actually experienced. This downside can be mitigated to some extent simply by purchasing multiple options contracts upfront.
Binary Option Strategies
Pinocchio strategy:
This is the perfect strategy to put into play if you come across a candle bar with an extremely long wick and a very small body during the course of your technical analysis. This type of bar is known as a pin bar, but it was given its more descriptive name because the longer the wick grows, the more likely it is to be giving you false information.
If you come across this scenario and the wick is already quite long, then you can generally assume that the price of the underlying stock will have moved about as far as it can in the current direction and that it will likely be reversing quite soon. As such, when you see this bar then you will know that your best bet is to start trading against the majority as the trend is likely going to turn and benefit your new position. After the wick begins shrinking, you will then want to generate a prediction on a call, and if it begins to increase again, then you will want to change your prediction to a put.
Binary options reversal strategy:
The effectiveness of this strategy is because the market naturally seeks balance which means that any price is bound to turn around eventually when confronted with extreme highs or lows. As such, when it comes to binary options, you can get a jump on the movement by predicting what is likely going to happen next.
For this strategy to work out effectively, you are going to need to predict the need for a put or a call based on the situation as it stands with help from information from external sources. You will find this to be a very useful strategy during periods of rapid asset movement because the speed at which it moves one way will be the same amount of speed with which it will eventually move back the other way. Because asset movement is bound to repeat itself eventually, once you understand its patterns you will be able to naturally tell when a given underlying asset is at its peak, making any relevant binary options a very clear-cut decision.
Martingale strategy:
In scenarios where you are more or less unconfident in the current state of the market but still want to keep an eye on a given investment, the martingale strategy can be quite useful. This strategy is also different than most other strategies as it involves heavily doubling down due to binary options’ unique characteristics. As an example, if you start with a $20 binary option that does not payout, then your next binary option should be worth $30 on the opposite side and so on and so forth until you make a profit. If your amounts get to the point where a $100 profit would not square you, then you would want to purchase multiple contracts at once.
This strategy is going to appeal to those who are naturally inclined to make risky investments that have a higher overall promise of return as well. With that being said, much of the risk can be minimized if you are familiar with the asset you are purchasing contracts on as you will already know the scope of the market and will not have to rely on the strategy to help you learn the ins and outs through unsuccessful contracts. This strategy is somewhat unique in that its odds of being successful are based almost entirely on your personal level of familiarity with the underlying asset.
Trade the news:
Buying into binary options contracts for a variety of assets based on the news is an effective means of working with binary options that is more multifaceted than it may first appear. At its most basic, it involves purchasing contracts when good news is forthcoming and selling them when bad news is on the horizon. Unlike other types of analysis, it is much less of science that goes in line with the more generalized nature of binary options in general. The most important thing you will need to learn from this type of analysis is how much of an effect a given piece of news is going to have on a specific underlying asset.
If you are fairly certain a specific piece of news is going to be released, and you are not sure how the market is going to react to it then the best way to ensure that you are going to end up making a profit is by setting up boundaries. To set up a bound binary option, all you need to do is pick 2 prices, one on either side of the current price of the underlying asset. As long as the price of the two is less than $50 combined you will still be making a reasonable profit, even after one of them expires at $0. The biggest risk with this strategy is that if the price does not move at all then both binary options are likely to expire at $0, costing you both the entry fees in the process.
Trading the breakout, the period right after the news has been released is another useful way to take advantage of crucial news whose effect was unclear prior to it being released. While this is a strategy you will no doubt see with many types of investments, it is especially challenging to use when working with binary options as the window for success can be as small as just 30 seconds, while never being larger than a few minutes.
The most prominent swings in asset price are going to happen during this period, so you will need to be prepared for this fact and ready to quickly jump on binary options created by traders who are looking to modify their positions in hopes of minimizing their own risk. As long as you have done your homework, and have a clear idea of what the news is likely to be, then you will then be able to buy into extremely short 60-second binary options and take advantage of all of the confusion.
Finally, if you are comfortable with technical analysis, then you will likely be able to take advantage of candlestick formations to help you trade the news more effectively. When you come across a candlestick with a gap in it, then you can safely assume that the price of that particular asset will have moved quickly from one point to another that is either much higher or lower to create it. As this much movement, all at once, is relatively uncommon, coming across one should be enough to give you pause and cause you to look at the asset that caused the gap more closely.
Over time, you will find that identifying the gap early on will allow you to make a wide variety of different predictions based on what the market was up to at the time. These include:
- If the gap is created during a period of low trading volume, then it is likely that the gap price will be corrected very quickly. This type of gap is generally formed after a large trade goes through after most of the institutional traders have called it a day. This means that the change does not actually reflect the strengths of the underlying asset so that you can easily set up binary contracts that take advantage of the fact that things will soon be moving back towards normal.
- If the gap occurs during a stretch where overall trade volume is up, but the movement on the underlying asset in question has been neutral then this can be thought of as a strong indicator that a new breakout is occurring which means that the potential for profits is increased. If you move quickly, you can take advantage of this fact by buying into contracts that line up with the direction the breakout indicates.
- Finally, if the gap appears during a space of average trading volume when the asset in question is already moving in a given direction, then the gap can be thought of as a sign that the trend that is being monitored is accelerating. This, in turn, means that the trend is likely to continue, at least in the short term. You will only want to be comfortable assuming the trend is going to last into a longer time frame if ancillary indicators are very strong.
