Over recent years traders have started hearing about a new trading product, but there’s a lot of questions and concerns about what they are and how they work. Binary Options are a type of derivative that are considered an “all-or-nothing” asset and is comparable to placing a bet on a sports game.
When you purchase a Binary Option you either make a predetermined amount based on how far out-of-the-money your option is or you lose your entire investment at the time of expiration. There is no in between and is why they are called “binary”, because there is only two outcomes.
Binary Options are similar to normal options in that they are expiring assets but they are very different in just about every other aspect. You cannot buy one and sell it back at a higher price if it trades in your favor.
You have to wait till the expiration to collect your winnings or realize your loss. Traders have found them attractive due to their simplicity but given their lack of regulation by the Securities and Exchange Commission (SEC) they tend to carry more risk and may not be suitable for everyone.
How They Work
When you buy a Binary Option you must predict where a stock, ETF or index is heading within a specified time frame.
So, for example, if the SPY is trading at $225 and you think it will close the day above $226 you would buy the binary call option at that strike and if the SPY closes above $226 then you will receive your winnings. However, if it does not finish above $226 then you will lose your entire investment. It’s as simple as that!
Binary Option Pros & Cons
Binary Options have both good and bad qualities about them. What I really like about them is that they take the emotion out of trading. You buy it and wait till expiration and either collect your winnings or accept your losses.
I also like how simple they are to trade and that you’re risk is limited to only the amount you invest. If you have ever traded normal options then you will have no problem trading Binary Options.
However, what I don’t like about Binary Options is you can’t cut losses if the trade is going against you and you’re susceptible to whatever news comes out during your time till expiration.
I also don’t like the fact that it is not accepted by all brokers or exchanges or regulated like normal options making them a riskier product. However, they may become a mainstream trading product one day so familiarizing yourself with them may be a good idea.