Binary Options

Binary options are also referred to as Digital Options, Fixed Return Options (FROs) or All-Or-Nothing options, since it is a type of trade where the return is all or nothing of a fixed amount.

Traders investing in binary option trading have only one of two choices to make. Up (Call) or Down (Put). Will the value of the underlying asset they are trading rise or fall within a fixed time frame.

Lets look at a quick example of a binary trade on the price of Gold.

At 12.00 GMT spot Gold is trading at 1,280 USD to the Oz. You want to speculate on the fluctuation of this price on a one-hour time frame (the expiry of the binary option will be 13.00 GMT)

Your analysis leads you to believe that the price of Gold will fall below its current price so you enter a Put option. How much that price will fall by is pretty much irrelevant as long as at the expiry time the price is lower than the current price of $1,280.

If at the expiry time (13.00 GMT) the price of Gold is below $1,280, you are in the money and your return will be you initial investment PLUS 80% of that investment. Assuming a $100 initial investment, your return on the Gold binary option would be $180.

If however the price of Gold has risen above $1,280 at the expiry time, you option will be out of the money and you will lose your initial investment.

There is a third possibility known as at the money where the entry price is the same as the expiry time, essentially a draw. In this even the initial investment is returned to your account with no deduction whatsoever.

Binary options are available on a wide range of underlying assets including Currency Pairs, Stocks, Indices and Commodities.

Binary options are not traded on margin or with leverage. The risk as well as the potential return is known in advance and traders know their exact exposure and potential profit prior to entering the trade.

Given their nature, binary options are considered one of the most simplified trading products available online. Binary options trading has a mass appeal as the entry requirements are not restrictive (OptionFX offers trading accounts with initial deposits of as low as $500) and they have a clear and defined risk profile. Unlike leveraged products, binary options can never fall into negative equity that is you never risk more than your actual positions.

Much like the forex markets, binary options are typically traded Over The Counter (OTC) and are not restricted to any one exchange. While the actual trade of these options is relatively straight-forward, the pricing engines behind the trades are complex and sophisticated. Typically binary options fall into the category of “Exotic Options”.