When you buy a traditional option, you can’t now at the time of purchase how large the profit will be if you make a profit on your option. You can make a $1 profit or a $100 profit or a $4,782 profit, and so on.
A binary option works differently, and you will know in advance how much profit you will make if you make a profit on it. With a classic binary option there are only two possible outcomes:
- Your prediction turns out to be wrong, which means that you lose the money you spent on buying the binary option.
- Your prediction turns out to be right, which means that you receive a predetermined award. The award can for instance be a specific amount of cash (example: $100) or a specific number of shares (example: 10 common stock shares in Spectra Energy).
For some binary options, the size of the award is determined by the level attained by the underlying instrument when the binary option expires. You may for instance get a $2 award for each $1 the stock price goes up above a certain level (when the underlying is a company share).
From Late Latin bīnārius (“consisting of two”), from Latin bīnī (“two-by-two, pair”).
- Being in a state of one of two mutually exclusive conditions such as on or off, true or false, molten or frozen, presence or absence of a signal.
The binary option is called binary option since there are only two possible outcomes. An alternative name is all-or-nothing option. A binary option where the reward is cash is known as a cash-or-nothing option. If the reward is a share or other non-cash asset, it’s an asset-or-nothing option.
How it works
A binary option can be tied to almost anything, but securities such as stocks are very common. It is also easy to find binary options tied to an index (e.g. stock index), interest rate or currency pair exchange rate.
Example: For a price of $200, you buy a binary option that states that the stock price for Aetna Inc
at NYSE will fall under $100 at some point before 2016-05-15 19:00 CET, and that you will get $360 if this happens.
If the prediction comes true, you get $360 and have thus made a $160 profit, which is an 80% return on your risked capital. If the prediction does not come true, you get nothing and has made a $200 loss.
Binary options often have a very short lifespan and it is possible to purchase a binary option that will expire a mere 10 seconds into the future! This is appealing for speculators that wish to attempt turning a small initial capital into a lot of money, even if it means taking big risks. Not only is it possible to find binary options with very large payouts (in relation to the purchase prize), but it is also possible for a savvy speculator to rapidly parlay $50 into $1,000 buy purchasing short-lived binary options and continuously using the profits to buy new ones.
Example: You buy a $10 binary option. 10 seconds later, the prediction has come true, and you receive $18. You immediately buy two $9 binary options, with a 10 second lifespan. You make money on both, and now you have $32. As you can see, it doesn’t have to take a long time to build up your bankroll using binary options. Of course, you can also lose your money very rapidly when employing this type of strategy.
Almost a binary option
In the wake of the enormous popularity garnered by the binary option online, several trading platforms have begun offering an option that is marketed as a binary option even though it isn’t binary in a strict sense of the world. It’s an option that essentially function as a binary option, but will give you a small consolidation price if your prediction comes close enough. The consolidation prize can for instance be 20% of the purchase prize of the option. You don’t get the real award because your prediction didn’t come true, but you do get a bit of the purchase prize back.
Example: You buy a binary option for $7 on October 1 that predicts that the share price of Nike, Inc will drop below $55 before 11:00 EST on October 2. When its 11:00 EST on October 2, the Nike, Inc prize has dropped significantly since yesterday, but not down to below $55. It did however go down to $57. According to the terms and conditions of your binary option, this is close enough for you to get 20% back of the purchase prize. You get $1.40 back and has only lost $5.60.
Buying binary options
Binary options are usually purchased online at individual trading platforms that issue their own proprietary binary options. There are many different sites to chose among online when you want to buy binary options. Unlike exchanges, these sites are (with few exceptions) open 24/7 and every day of the year. Examples of popular trading platforms include 24option, IG index and Banc de Binary. (We are currently trying these platforms and hope to be able to post our own reviews soon. Until then we link to the reviews provided by one of the most trusted binary option websites, binaryoptions.co.uk )
Two examples of authorities that license vendors of binary options are the Cyprus Securities and Exchange Commission (CySEC) and Malta’s Financial Service Authority.
CySEC was the first EU MiFID member to classify and regulate binary options as a form of financial instruments. Since May 2012, all vendors of binary options operating based in Cyprus must be licensed by CySEC. In many other jurisdictions around the world, binary options are either unregulated or regulated as gambling.
In Malta, binary options fell under the auspices of Malta’s Lottery and Gaming Authority until 2013, when binary options were classified as financial instruments and became the responsibility of Malta’s Financial Services Authority. All vendors of binary options based in Malta must have a Category 3 Investment Services license and conform to MiFID’s minimum capital requirements.