What are Binary Options? The Complete Guide

We often get asked:  What are binary options? Binary options are one of the popular ways to make money trading financial instruments. They’re quite different from traditional options in terms of who offers them, their liquidity, rewards and risks as well as payouts. Also, they’re more accessible to traders compared to traditional options thanks to online brokers that allow you to trader from anywhere in the world.

Any trader wishing to invest in binary options must understand the risks and potential rewards involved. It’s also important to understand that not every company offering binary options is legit. That’s why we’ve created this site to guide you through some of the top binary options brokers available today.

What are binary options?

Often classified under exotic options, a binary option is a financial option where the returns are either a fixed amount or nothing at all. Usually, the fixed monetary return is $100. Binary options go by different names depending on where you’re trading from. The names include fixed return options (US), all or nothing options and, fixed time trades.

Another way to describe binary options is how they operate. A single transaction dealing with binary options is based on a simple yes or no proposition depending on how the trader speculates a financial instruments price will move. The trader will simply make a purchase (call) or sell (put) depending on how they answer the question:

Will the price of the financial instrument traded be higher or lower than the current price at the expiry period

If the trader speculates that the price will be higher, making a call will be the next step. If however, the trader speculates a drop in price, he or she will place a put. Upon expiry, traders who make correct speculations make profit. However, those who speculated incorrectly will lose their investment.

But what happens if at the expiry period, the price hasn’t changed?

In most cases, you will get your investment back and won’t incur any loss or gain profit. The amount refunded however depends on your broker. Binary options allow traders gain access to different globally traded assets including precious metals, currency pairs, indices, commodities and stocks.

However, rather than actually buying the underlying asset (for example buying Google stocks), you’re trading on the underlying asset’s price movements. This allows you to invest as little as $10 on a single trade.

A detailed example showing how binary options work

You have decided to trade the S&P 500 index which is currently trading at $1430. After consulting the different charts and technical tools, you conclude that the price is going to rise over the next few hours. However, you cannot predict by how much. You therefore decide to place a call (buy).

Since the broker offers several expiry periods that range from 5 minutes to 1 month, you decide to hold the trade position for 10 minutes. That is, if after 10 minutes the price of the S&P 500 index is over $1430, you’ll make a profit. If it’s lower, you’ll lose your investment. Your broker indicates that you’ll earn a 70% on your investment (profit).

Depending on your account management strategy, you decide to invest $100 on the trade (we usually recommend about 2% of your total account value). At expiry time, the price of the S&P 500 index is $1432. An increase of $2. This means that you have made a $70 profit (70% of $100). You account is therefore credited with $170.

Note that the $2 increase in the price of the S&P 500 index is not your profit since you don’t actually own the asset. Your profit is earned on the amount you invested. Therefore, if S&P index price dropped to $1429, you would have lost your $100 investment. On the other hand, if the price at expiry remained at $1430, it’s likely that your broker would simply refund your $100.

This example describes a simple high/low options trade. Today’s brokers often offer other exotic options trades that include one touch and range. Here’s a brief overview about how each one works.

How one touch binary options trades work

Using the example above, one touch trade rules require the S&P 500 price movement must touch a predetermined price level before the expiry period. You are usually provided with two price levels, one above the current price and one below it.

Still using the S&P 500 current price of $1430, your broker might provide a price range between $1400 and $1460. After analysis, you conclude that since the price is rallying, it should hit $1437 before it starts dropping. You also conclude that it will hit $1437 within 150 minutes.

Using the one-touch trade, you simply place your price level at $1437 or lower and an expiry of 150 minutes.
If the price reaches $1437 before the expiry period, you’ll make a profit. If however, it never reaches $1437, you’ll lose your investment.

How range binary options trades work

As the name suggests, range binary options trades allow you to speculate a specific price range within which you expect the underlying assets price to remain within for a specific amount of time. Profits are earned if the price remains within the selected range upon expiry of the trade.

Using the example above, the range would be between $1430 and $1437 within 150 minutes. If the price drops below $1430 or rises above $1437, you’ll lose your investment.

As you might have noticed, exotic binary option trades come with high risk and reward potential compared to high/low trades. While classic high/low trades offer returns between 50% and 85%, exotic trades can offer returns of up to 500%.

A higher return makes it easy to make enough profit to cover losses you might incur on other trades. However, you’re advised to be careful when entering trades that offer unrealistically high returns since potential of incurring loss is usually higher than that of making a profit.

Trading binary options from different regions in the world

If you’ve been shopping around for a reliable binary options broker, you might notice that some brokers will reject traders from specific regions. The reason for this is that binary options brokers need to be licensed and regulated to offer their services to citizens of specific countries. Many binary options brokers have actually been charged and fined by regulators from different countries. For example, the US Securities and Exchange Commission (SEC) charged and fined a Cyprus based broker for selling binary options to US citizens illegally in 2013. The same firm was also fined by its regulator CySEC.

Choosing a binary options broker, therefore, requires that you first consider your home country and the local laws that regulate binary options trading. Some countries have actually banned binary options. It also requires that you consider whether the broker is licensed and regulated by the financial authorities within your country. Regulation ensures that your funds are insured and thus protecting you against investing your money with scam businesses.

Comparing binary options trading in the US and non-US countries

Binary options trading in the US is heavily regulated. Brokers that are allowed to offer binary options to US citizens must be licensed and regulated by either the Securities and Exchange Commission (SEC) or the Commodities Futures Trading Commission (CFTC). As such few brokers from outside the US offer their services to American citizens.

Binary options trading outside the US is also heavily regulated. However, there still exist brokers that offer their services without having a license or being fully regulated. Some of the well known regulating bodies include Cyprus Securities and Exchange Commission (CySEC) and, Australian Securities and Investment Commission (ASIC). Countries such as
Israel and Canada prohibit binary options trading.

In the US, binary options are typically offered byexchanges. These simply provide a platform where a willing buyer and seller meet to trade options. Exchanges earn money by charging a small fee on every trade entered. One of the popular exchanges operating in the US is Nadex. It’s regulated by the CFTC.

Outside the US, binary options are usually offered by individual brokers. Brokers earn money by calculating a percentage difference between what they pay out on winning trades and what they deduct on losing trades. Some brokers will also charge fees and commissions on trades and individual trader accounts.

The price of binary options for both brokers and exchanges in all regions of the world are quoted between 1 and 100. This price fluctuates throughout the trade period. The price fluctuations are what make it possible to earn profit or loss on a trade.

Also, traders will always know the profit or loss potential of every trade regardless of the broker they’re investing with. The profit and loss are capped at $100 and the invested amount respectively.

Many exchanges and brokers from all over the world also offer special tools that allow traders to minimize losses or close in profits. These include stops and ability to exit a trade before the expiry period. In some instances, the broker might deduct a small fee for exiting a trade before it
expires.

Advantages of binary options trading

One of the main advantages of binary options trading is that you’ll know the potential profit or loss. Every trade usually has two potential outcomes. If the trade is successful, you’ll earn a fixed profit. If the trade isn’t successful, you’ll lose your investment. This makes it easy to identify trades where the profit potential is higher than loss potential.

Another advantage is that many brokers won’t charge any commissions or fees on trades entered. This allows you to keep as much of your earnings as possible. However, brokers vary so it’s important that you choose a broker that doesn’t impose fees or commissions on your trades. Some brokers will even cover the transaction fees that you might be charged by a payment
processor when depositing or withdrawing funds from your account.

Trading binary options is also quite simple. All you need to do is analyze a particular financial instruments price movements and speculate whether the price is going to rise or drop over a specific time span.

As a binary options trader, you can invest as little as $1 on a trade that involves an instrument that’s worth much more than this amount. There are no liquidity concerns since you don’t actually own the underlying asset.

Many binary options brokers are offering a wide range of useful tools and features that make it easy to keep track of the financial markets, manage your account and try out different trading strategies. These usually come at no additional cost and, are available on their platform.

Finally, binary options trading gives you access to different assets classes available in financial markets across the globe. As long as you have access to your trading account, you will be able to access any market that’s open.

Disadvantages of binary options trading

One of the main disadvantages of binary options trading is that a single loss might require several winning trades to cover. Several losing trades can essentially drain your entire trading account. It’s therefore important that you use a proven trading strategy and carefully analyze a specific instrument’s price movements before entering a trade. And easy way to try out your trading strategy is through a demo account where you don’t have to risk your own money.

Many brokers operating outside the US are unregulated. Investing your money with such brokers doesn’t guarantee that your money is insured. We always advise that you carefully research a broker before opening an account with them.

 

Conclusion

Binary options trading is an easy way to earn a fixed return by speculating on a financial instruments price movements. It’s one of the best
ways to start trading financial instruments without having to invest a huge amount. There are many brokers and exchanges to choose from both in the US and in other countries. Regulators across the globe have made efforts to control protect traders from scam brokers by licensing and keeping an eye on legit brokers. However, the number of unregulated brokers operating outside the US remains high.

Trading in binary options has several advantages that include low capital requirements to get started and, easy access to global financial markets. As with any other market that involves trading financial instruments, binary options trading involves some risks. A single losing trade might require several winning trades to recover. Even so, many traders are making money in this market by adopting proven trading strategies and using available broker provided tools.

If you want to start trading binary options, it’s important that you first have a good understanding about how financial markets work and take time to find a reputable broker.

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