Binary options are a simple way to trade price movement in a range of global financial markets. Classed as exotic options, they can be bought in both directions on virtually any financial product. With only two possible outcomes available and a fixed expiry time on every trade, binaries are an easy-to-follow system that many people find attractive. While binary trading comes with a number of associated risks, these instruments have exploded in popularity during recent years.
As the name would suggest, a binary option is a specific type of financial option where only two outcomes are possible. Unlike traditional options that come with a continuous pay-off spectrum, binaries pay either a fixed monetary amount or nothing at all. The easy-to-understand and simple-to-follow nature of binary options has made them a big hit with novice traders, with more seasoned investors also using them in addition to other trading systems.
There are two main types of binaries available, cash-or-nothing options and asset-or-nothing options. Depending on the financial instrument in question, cash-or-nothing options pay a fixed amount of cash if they expire in-the-money, while asset-or-nothing options pay a defined value of an underlying security. Binary options have exploded in popularity over the last few years, and are also known as digital options, all-or-nothing options, and fixed return options (FROs) depending on market and location.
Binary options can be bought in both directions, with traders making either a Call/Up option or a Put/Down option on a specific financial product. For example, if you think an asset is going to rise in value before the maturity date, you would purchase an Up option, with a Down option available if you are feeling bearish. The simple nature of this operation is attractive to many traders, with the digital nature of trade direction and fixed expiry time the only two execution variables that need to be taken into account.
When a contract is purchased, the only thing left to do is wait and see if your trade is successful. While the same level of detailed analysis is required before making a decision, this way of trading is a huge contrast to other systems which also require complex and stressful stop-loss and take-profit decisions. While other complexities arise from the variety of expiration times available and opaque transaction cost structure, binary trading is generally easier to understand and implement due to the fixed risk/reward structure.
Like all financial investments, however, options trading can be a risky endeavour. While there are less decisions to make while making trades, it’s just as important to develop a good strategy based on solid technical and fundamental analysis. It’s also vital to realise not every trade will be successful and develop sensible money management rules that take both wins and losses into account. A sensible rule of thumb is to invest an absolute maximum of 5 percent of your capital in any one trade, with many traders putting the limit much lower at 1 or 2 percent in any individual trade.
Markets of Operation
Binary options have exploded in recent years, with a growing number of brokers offering digital contracts to their customers. They are very popular in major European exchanges like EUREX, with the market also growing in the United States through The Chicago Board of Trade (CBOT) and American Stock Exchange (Amex) among others.
Amex offers binaries, called ‘Fixed Return Options’ (FROs), on some ETFs and a few highly liquid entities such as Citigroup and Google. The Chicago Board Options Exchange (CBOE) offers them on the S&P (SPX) and CBOE Volatility Index (VIX), with Nadex also offering a range of forex, commodities, and stock indices markets.
Non-exchange-traded binary options are also widely available through a number of trading platforms, with roughly 100 platforms in operation offering options on close to 200 underlying assets. However, both the U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have issued a joint warning to American investors regarding unregulated option trading, so it’s always important to do your homework before you choose a broker and start trading.
History of Binary Trading
Options have been getting so much attention lately, it’s easy to think they just came out of nowhere. The concept has been around for a long time, however, with early over-the-counter transactions often involving simple on/off trades between market participants. It became much easier to trade options after the Chicago Board of Trade created the first structured options trading environment in 1971 by forming the Chicago Board Options Exchange (CBOE).
Even after the creation of the CBOE, however, binary options were still the domain of elite traders, with major contracts available solely as over-the-counter transactions through licensed brokers. Changes to this structure finally took place in 2007, with the binary market growing around the world since this date. While they could be traded prior to 2007, they were extremely complicated and not open to the general public due to a minimum amount of regulated supervision.
Digital Options Trading was defined properly and made legal in 2007 after the OCC (Option Clearing Corporation) passed a rule with the SEC (Securities Exchange commission) allowing binaries to be traded over the counter in major markets around the world. In May of 2007, the American Stock Exchange became the first international exchange to offer binary options publicly, with the CBOE following suit in June.
While originally defined as digital options, the term binary slowly spread into mainstream use. Expanding uptake by brokers and the introduction of new and sophisticated platforms and tools has seen binary options grow in popularity since 2007. With greater market flexibility and a larger diversification of underlying assets, traders now have access to a range of contract types, strike prices, and expiry times. The simple Up/Down order has expanded into a full range of options based on trigger points, price ranges, contract times, and asset relationships.
Binary Trading continues to expand within the investment industry, as new traders are attracted to the simple rules and easy implementation of digital trading. While the dangers of financial risk are just as large as ever, the possibility of increasing potential profit without having to study and master a wide range of trading subjects continues to attract new investors. However, like any form of financial investment, new traders are always advised to learn as much as possible before getting started.