Binary options are short-term financial instruments based on a simple yes/no question
A Binary Option Has Three Components:
1. Underlying Market
A binary option’s price is based on an underlying market. That market could be a stock index future, a commodity like gold or crude oil, a forex pair like the EUR/USD, or even an economic event like the weekly jobless claims number.
2. Strike Price
Each binary contract has its own strike price, which is the price level you think the market will be above or below at expiration.
3. Expiration Date and Time
The expiration date and time is when trading on the binary option stops. If you are still holding a position at expiration, you will either receive the full $100 payout or nothing.
Market, Strike Price, Expiration Time
A binary option contract in gold might be called:
Gold (Aug) > 1250.00 (4:15PM)
- The underlying market is August gold futures (traded on the CME)
- The strike price is $1250.00/ounce
- The expiration time is 4:15PM today
If the price of August gold futures is above 1250 at 4:15PM, the buyer of this binary option receives $100 and the seller will get zero. If gold futures are at or below 1250, the seller gets $100 and the buyer gets nothing.
How Do Binary Options Work?
Binary options focus each trade on a simple yes/no question
All binary options are based on the same kind of yes/no question about an underlying market:
- Will the price of gold futures be above 1250 at 4:15PM? Yes or no?
- Will the Dow Jones stock index be above 24,000 at 1PM? Yes or no?
- Will the EUR/USD exchange rate be above 1.1500 at 4:15PM Friday? Yes or no?
If you think the answer is yes, you buy the binary option.
If you think the answer is no, you sell the binary option.
At the expiration time, whoever is correct, buyer or seller, will get the full $100 value of the option. The other trader will get zero.
However, before expiration, the price of the binary option will go up and down as traders react to the movement of prices in the underlying market. During that time before expiration, you can buy and sell the binary the same way you’d trade any other instrument: buy low, sell high.
Binary options let you trade a world of markets
The simple, flexible design of binary options makes them suitable for many markets, including stock index and commodity futures, forex pairs, and even economic numbers like the weekly jobless claims or the Fed interest rate.
You can trade all of those asset classes from a single account and combine them in whatever strategies you can imagine. Think the Fed will raise rates and strengthen the US dollar? Buy a weekly binary on the Fed Funds and sell the EUR/USD.
You can use binary options on stock indices to hedge against fluctuations in your stock portfolio. Or explore gold, crude oil, and other commodity trading in a way that is low-cost with capped risk.
Binary options offer unique trading advantages
Binary options are an affordable way to learn to trade. Start with one binary option contract at a time for less than $100. With binaries, you decide your maximum risk and reward up front. If you buy a binary for $30, hoping to have it expire at $100, then your risk is 30 and your profit target is 70.
That makes risk management dead simple. You can’t lose more than $30 (plus the $1 fee) even if the underlying market crashes. And because you have a built-in profit target, you can plan your exit strategy with confidence.
You can hold it until expiration or exit early.
For example, if you bought a binary for $30 and it goes up to $70, you can place an order to collect your $40 profit now, rather than wait until expiration.
Similarly, if you sold at 50 and the binary option is now worth 80, you can exit early with that $30 loss rather than face the possibility of a $50 loss at expiration.
Binary options on a CFTC-regulated, US-based exchange like Nadex can be a powerful, trustworthy way to add day trading, swing trading, and even scalping strategies to your portfolio.
Example: Trading forex using binary options
Will the current EUR/USD exchange rate be greater than 1.1600 at 3AM ET?
Let’s say you want to trade the EUR/USD > 1.1600 binary option which has four hours left until expiration. It’s currently 11PM. (On Nadex, you can trade 23 hours, Sunday through Friday.)
So your trade is based on the above question.
Let’s say you are bullish and you think the answer is yes, the EUR/USD rate is going to be above $1.16 at 3AM. You would then buy the binary.
You might buy the binary in several scenarios. The EUR/USD might already be above $1.16 and you think it will stay there. It might be in an uptrend and even though it’s currently at $1.15, you expect it to go up. Or, you might have some other investment which is affected by a strong euro and you might want to hedge against a rate increase. Binary options are useful in a variety of trading strategies.
The final outcome will be determined at expiration: If the market is at or below 1.1600 at 3AM ET (the expiration time), the seller will get the $100 payout. But if the market is even one tick above 1.1600, you, the buyer, get the full payout. That is the all-or-nothing outcome at expiration.
And again, if you don't want to wait until expiration, you can exit your position at the current market price. Your profit or loss in that case is the difference between your entry and exit prices.
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