Ultimate Beginners Binary Options Guide
Binary options trading is one of the least-understood forms of trading on the market today.
When done correctly, binary options trading is the world’s best get rich quick scheme...When done wrong, you can lose a lot of money extremely fast.
What exactly is binary options trading and how does it work?
Find out today in our ultimate guide to binary options trading.
What is Binary Options Trading?
Binary options trading is based on the concept of guessing “yes” or “no”.
In this case, “yes” or “no” corresponds to the price of an asset going up or down. At least, that’s the simplified version of it.
Binary options traders are given a question: do you think the price of the underlying asset will be above at a certain price at a certain time? You place a trade based on whether you think the answer is yes or no.
It’s a ridiculously simple concept. This simplicity has attracted all sorts of beginner investors to the world of binary options trading. They all hope for the same thing: make a quick buck with no risk.
Unfortunately, there’s no such thing as a no-risk way to make money. It just doesn’t exist. Every investment comes with some risk. In binary options trading, both your risk and your reward are capped.
The main risk with binary options trading is that you’re working with very short timeframes. In some cases, you’re betting that the price of an asset will go up or down within the next 5 minutes. Unless you know the company is about to make a major announcement, that can be a difficult – some would say impossible – call to make.
That’s why some people argue that short-term binary options trading is a game of luck masquerading as a game of skill.
If, however, you’re working with daily or weekly time frames, you can begin to make a more educated guess about the path a binary option might take.
Binary Options Trading in the United States
Binary options trading is primarily an American phenomenon. Outside the US, binaries are structured differently. For the purpose of this article, I’m going to assume you’re looking at binary options trading within the United States.
Investopedia describes American binary options trading as providing “a way to trade markets with capped risk and capped profit potential, based on a ‘yes’ or ‘no’ proposition.”
Let’s start with an example binary options question: Will the price of oil be above $50 per barrel at 1:15pm today?
If you believe oil will be above $50 per barrel at 1:15pm (yes), then you would buy that binary option.
If you believe oil will be below $50 per barrel at 1:15pm (no), then you would sell that binary option.
Binary options are always priced between $0 and $100. They come with a bid and ask price – just like other financial markets.
The option listed above might be trading at $44.50 (bid) and $46.50 (offer) at 1pm. If you decide to buy the binary option right then (yes), then you will pay $6.50. If you decide to sell (no), then you would sell at $44.50.
Let’s say you buy at $46.50. At 1:30pm, the price of oil is above $50 per barrel. Your option expires after 1:30pm and immediately becomes worth $100. You would make a profit of $100 minus $46.50 for a total of $53.50. Your profit is $53.50 (less fees) and you are officially considered to be “in the money”.
If, however, the price of oil is below $50 per barrel at 1:30pm, then your option expires at 1:30pm and becomes worth $0. You lose the $46.50 you invested and are “out of the money”.
The bid and offer prices constantly fluctuate until the moment the option expires. You can close your position any time before the option expires. Say, if you want to lock in a profit or reduce a loss. Closing your option early can reduce a loss because you avoid letting it expire out of the money.
Binary Options Trading is a Zero Sum Game
The reason why some people are hesitant about binary options trading is because it’s a zero sum game. That’s not an opinion: that’s a fact.
A zero sum game means that when you profit, someone else loses. When the option expires, it’s either going to settle at $100 or $0. It will be $100 if the binary option proposition is true, or $0 if the binary option is false.
That’s why every binary option has a total value potential of $100. In order for you to make money, someone else needs to lose money.
You can sell or buy as many binary options contracts as you want.
How Are Binary Options Prices Determined?
The market – buyers and sellers – determine the price of binary options. These prices give you a crucial look at how the binary option is expected to proceed:
-If the bid and ask on a binary option are at $88 and $93, respectively, then traders are assuming that the outcome of the binary option will be “yes”, because people are willing to pay close to the maximum potential earnings price ($100) for that option
-If the bid and ask are near 50, say 45 and 55, then traders are unsure how the trade will proceed. If you choose right, there’s a big reward. Choose wrong, and there’s a big loss.
-If the bid and ask are at 15 and 20, then traders expect the outcome of the binary option to be “no”, which means it will expire with a value of $0. Those who buy binary options at these prices are making a low-risk investment for a huge potential gain. Those who are selling are trying to limit their losses.
How Do You Trade Binary Options?
You can trade binary options through any investment account which allows for options trading.
Ask your bank or your investment platform if they allow options trading. If not, then you’ll need to sift through hundreds of low-quality online options trading platforms to find one that doesn’t try to scam you.
Binary options trading is one of those things that has gained an unfortunate reputation thanks to the internet. There are hundreds of low-quality brokerages that would love to take your money online.
Make sure you thoroughly research your broker prior to signing up.
Fees vary widely between brokers. Most binary options cost between $0.50 to $2 to enter and exit. However, brokerages will typically cap a fee at a certain limit. If you buy 20 lots, for example, your fee may be capped at $10 or $15 (or whatever your broker’s cap may be).
If you hold the trade until settlement and finish out of the money, the broker won’t charge you a fee to exit. If you finish in the money, however, the broker will charge you the same entry/exit fee mentioned above.
What Kinds of Binary Options Trades Are Available?
Binary options trades are available across a wide range of commodities, indices, and markets. Here are some of the most common assets you’ll encounter when dealing with binary options:
Currency pairings: Place binary options trades on currency pairs, like EUR/USD, USD/CAD, GBP/JPY, and USD/JPY.
Markets: Trade on major market indices, like the Dow 30, S&P 500, and Nasdaq 100.
Commodities: Popular commodities for binary options trades include crude oil, gold, silver, soybeans, corn, copper, and natural gas.
News and Announcements: Trade news events – like whether the Federal Reserve will raise or lower rates, or whether jobless claims will be above or below estimates.
You can choose to trade binary options based on different time frames. Popular time frames include weekly, daily, and hourly options. Some options also expire after a certain event – say, when the Federal Reserve announces a rate change.
Pros and Cons of Binary Options Trading
-The risk is capped. You can’t lose more than the cost of the trade.
-It’s possible to earn higher-than-average returns, especially when trading in quiet markets. Let’s say you’re looking at a stock that has barely moved over the past few years. It’s stayed within 5% to 10% of its price. You’re not making or losing much money. With a binary options trade, you can buy in at $20 to make $80. Few other investments give you a 4:1 reward to risk ratio – especially in quiet markets.
-Since binary options are always priced between $0 and $100, they’re affordable for traders of all budgets, backgrounds, and portfolios.
-You can begin with a deposit as low as $100
-Your risk is capped, but so are your gains. With stocks, you can ride the stock as high as it goes. With options, the absolute maximum value is $100 (although you can buy multiple options contract to maximize profits).
-You’re not buying a stock, an asset, a commodity, or anything of concrete value. You’re buying a derivative of an asset. Obviously, this means you don’t have voting rights or dividends when working with binary options.