Basics of Binary Options Trade: The True Definition of Binary Options Trade

Introduction:

In finance, a binary option trade is a type of option in which the payoff can take only two possible outcomes, either some fixed monetary amount (or a precise predefined quantity or units of some asset) or nothing at all (in contrast to ordinary financial options that typically have a continuous spectrum of payoff).

The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option.

The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. They are also called all-or-nothing options, digital options (more common in forex/interest rate markets), and fixed return options (FROs).


Call/Put

Call options are made if a buyer thinks that the price of a commodity  will be equal or above the the strikeprice (price at purchase) of the commodity at expiry time.


Put options are made if a buyer thinks that the price of a commodity will be below the strikeprice of the commodity at expiry time.


For example, a purchase is made of a binary cash-or-nothing call option on XYZ Corp's stock struck at $100 with a binary payoff of $1,000. Then, if at the future maturity date , often referred to as an expiry date, the stock is trading at above $100, $1,000 is received. If the stock is trading below $100, no money is received. And if the stock is trading at $100, the money is returned to the purchaser.

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Read also: List Of Fully Accredited And Regulated Binary Options Brokers: How to choose a good broker.

Example of a binary options trade:

A trader who thinks that the EUR/USD price will close at or above 1.2500 at 3:00 p.m. can buy a call option on that outcome. A trader who thinks that the EUR/USD price will close at or below 1.2500 at 3:00 p.m. can buy a put option or sell a call option contract.

At 2:00 p.m. the EUR/USD price is 1.2490. The trader believes this will increase, so he buys 10 call options for EUR/USD at or above 1.2500 at 3:00 p.m. at a cost of $40 each.The risk involved in this trade is known. The trader’s gross profit/loss follows the "all or nothing" principle. He can lose all the money he invested, which in this case is $40 x 10 = $400, or make a gross profit of $100 x 10 = $1,000. If the EUR/USD price will close at or above 1.2500 at 3:00 p.m. the trader's net profit will be the payoff at expiry minus the cost of the option: $1,000 – $400 = $600.

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The trader can also choose to liquidate (buy or sell in order to close) his position prior to expiration, at which point the option value is not guaranteed to be $100. The larger the gap between the spot price and the strike price, the value of the option decreases, as the option is less likely to expire in the money.In this example, at 3:00 p.m. the spot has risen to 1.2505. The option has expired in the money and the gross payoff is $1,000. The trader's net profit is $600.

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