What are binary options and how do they work?

Binary option contracts offer defined risk and clear outcomes. They are considered ‘binary’ because there are only two possible outcomes at expiration: you either make a predefined profit, or you lose the money you paid to open the trade. This makes it easier for you when deciding whether to trade, as you know exactly how much you could lose if the markets move against you. And if they don’t, you know the exact size of your potential profit, making this a controlled, yet exciting way to trade. 

What is a binary option?

A binary option is a financial instrument that turns every trade into a simple yes or no question – you decide whether a market is likely to be above a certain price, at a certain time. If you think it will be, you buy. If you think it won’t be, you sell.

When you place an order for a binary option contract, you are speculating on the market rather than buying a share of the underlying market. The price is always between $0 and $100.

How do binary options work? 

There are three key elements that make up a binary option contract. These are:

  • The underlying market. This is the market you choose to trade – Nadex offers forex, stock indices, commodities, and events.

  • The strike price. This is the all-important price level. The strike price is central to the binary option decision-making process – to place a trade, you must decide if you think the underlying market will be above or below the strike.

  • The expiration date and time. You can trade binary option contracts lasting for up to one week, with a duration as short as five minutes.

There are four markets you can speculate on with binary option contracts:

  • Forex

  • Stock indices

  • Commodities

  • Events

Contracts are available day and night. The Nadex platform is designed simply, so at any one time, you can see what contracts are available to trade.

Trading binary options with Nadex is intended to be fast-paced and exciting – traders choose short-term options over long-term investments because they offer defined risk, but also because they’re fun to trade! Binary options trading is an opportunity that can be explored by people with all levels of experience. 

Binary options trading explained

Trading a binary option is like asking a simple question: will this market be above this price at this time? If you think yes, you buy, and if you think no, you sell.

Binary options are priced between $0 and $100, so you can decide how much capital you can risk. Each contract will show you the maximum you could gain and the maximum you could lose, so you’re always making an informed decision and losses don’t spiral out of control.

If your trade is successful, you receive a $100 payout, so your profit will be $100 minus the money you paid to open the trade. If your trade isn’t successful, you don’t receive a payout. This means you lost your capital, but nothing else, because your risk is capped.

If you find that you want to exit a contract early before it expires, you can place another order to close your position, limiting losses or locking in profits.

Learn how to trade binary options

Trading binary option contracts is a simple process, but understanding the ins and outs of the underlying markets and picking the right trading opportunities for you will take some research and some work. Don’t worry though, we can help! Here are some further resources to explore:

Binary options trading example

Here is an example of how to trade binary option contracts, using the EUR/USD currency pair:

EUR/USD > 1.1600 (3 a.m.)

The expiration time for the trade is 3 a.m. Simply put, this binary option is asking you: will the EUR/USD currency pair be above 1.1600 at 3 a.m.?

If you think it will be, then you buy. If you think it won’t be, you sell.

In this case, let’s say you buy.

If so, then there are two possible outcomes:

  1. The indicative index price is at or below 1.1600 at 3 a.m. This means no payout this time and you lose the capital you put up to place the trade. The seller will get the payout instead.

  2. The indicative index price is one tick or more above 1.1600. You get the $100 payout.

If you don't want to wait until expiration, you also have the option to close your position at the current market price. Your profit or loss in that case is the difference between your entry and exit prices.

Ready to start trading binary option contracts? Sign up for a Nadex account! You can be up and running in minutes.

Want to practice first? Sign up for a Nadex demo account! You’ll get practice funds, so you can hone your skills before trading for real.

How are binary options regulated in the US?

Binary option trading in the US is regulated by the Commodity Futures Trading Commission (CFTC) and it is only legal to trade binary options on a CFTC-regulated exchange. The CFTC is a US government agency that oversees the derivatives markets and works to protect market participants and the public from fraud, manipulation, abuse, and systemic risk.

Nadex is registered as a Derivatives Clearing Organization (clearinghouse) and is also a Designated Contract Market (exchange) with the CFTC.

Advantages of binary option contracts

As with any type of financial instrument, there will always be advantages and limitations when trading binary option contracts.

These are some of the key advantages of trading with binary option contracts:

  1. The opportunity to profit regardless of market direction. You can buy or sell depending on your market predictions.

  2. Fixed risk. You know all possible outcomes before you trade, allowing you to manage your own risk effectively.

  3. Simple yes and no questions. Binary option contracts can be a good introduction to the markets if you are new to trading. Likewise, they can form a central part of your trading plan if you are a more experienced trader.

  4. The option to close a trade early. If you want to close a trade early to keep your profit or limit losses, you can place another trade.

These are some of the key points to consider to protect yourself before trading with binary option contracts:

  1. You need to be self-disciplined. As with any kind of financial instrument, you need to be disciplined and manage your own risk. Learn more about risk management strategies.

  2. Education for binary options can be limited. Not at Nadex, though – explore our binary option contracts education section and learn the ropes.

  3. You need to put in the work. You still need to know your markets, put in the work and make a clear trading plan if you want to become a successful trader. We’ve made it as easy as possible for you – but you need to make your own market decisions!

Binary options key takeaways 

Binary option contracts can offer fast-paced trading opportunities with limited risk, making them the ideal option for traders with all levels of experience.

It’s important to remember to follow your trading plan and to manage your risk. This will protect you from risking too much capital and losing more than you can afford.

Try trading binary option contracts risk free with a Nadex demo account. You get $10,000 in virtual funds, so there’s absolutely nothing to lose. The best way to learn about binary option contracts is to trade them – and we let you practice for free.

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