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What are binary options?

Binary options are some of the simplest financial derivatives, which offer experienced traders as well as complete beginners the chance to trade the markets profitably.

Binary options are simple yes/no propositions. The trader makes a prediction regarding the price of an underlying asset, or rather, the direction in which this price will move within a specified period of time. A binary option trade is completely defined by the following variables: the amount of money one invests on the trade (which determines the amount of profits/losses), the expiry period and the direction of the prediction. The simplest binary option type is the Call/Put one (also called "classic" by some brokers).

Example

Here's an example of a Call/Put option: The trader decides to make a $25 investment on the Call side of the EUR/USD pair, with a 15 minute expiry. Here's what all that means: our trader believes the value of the EUR/USD will head upwards from its current level, and 15 minutes from the placing of the trade, it will be higher than it is when the trade is actually placed. If - upon expiry - the value of the currency pair is indeed above its current value, the trade expires in the money, and the trader pockets a 70-90% return, depending on the return rate offered by his broker on this particular trade. If the EUR/USD ends up under its current value, the trade expires out of the money and the traders loses his investment (or gets a rebate of up to 15% on it, depending on whether or not his broker offers such a perk).

Daweda

When trading binary options, one doesn't actually take possession of the traded asset. That's why binary options are called derivatives. Unlike regular, vanilla options, binary options do not confer traders the right to buy or sell a specific asset for a specific price at expiry. Therefore, it is safe to say that the two option-types are indeed radically different.

Binary options are known by a number of different names. On the Forex market, they're called digital options. The American Stock Exchange has them called all-or-nothing options or fixed-return options (FROs). Every one of these names is correct, and they all reflect it well that binary options entail only two possible outcomes: win or loss.

Besides the above described Call/Put options, most brokers offer a selection of other binary option types, twisted and turned into a diverse range of variants, to accommodate a larger number of trading strategies and to add a little bit of depth to the trading scene, which would otherwise be quite shallow.

One Touch options feature a target price. Traders attempt to predict whether the asset price will reach this target or not. In the case of Boundary options, traders predict whether the asset price will break out of a predetermined range or not. Ladder options represent a twist on One Touch options: they feature several target prices, which the asset price can reach one after the other. In regards to various binary option types, there seems to be a bit of a competition among brokers, who all aim to come up with as interesting and original variants as possible.

Advantages of binary options

The advantages of binary options are fairly obvious. They are very simple and easy to understand for everyone. Figuring out the trading interface will only take a few seconds, even for those who have never traded in their lives. Most importantly though, with binary options, all the variables of the trading equation are known before trades are launched, and that includes potential returns and losses too. In binary option trading, there is no leverage and margin. Traders cannot lose more money than they invest and indeed, they know exactly how much they stand to win/lose on every trade, before they pull the trigger.

Trading strategies

Given the wide array of binary option types available, the genre as a whole lends itself well to a wide range of trading strategies. While proper fundamental and technical analysis is always a plus, in the case of binary option trading, one can theoretically trade profitably using the most basic strategies, or copying the trades of a more experienced peer. Auto trading is available too, though in this regard added caution is recommended as there are scores of scams linked to this vert.

Disadvantages

The disadvantages are also simple and straightforward. There are many unlicensed and unregulated brokers out there, who peddle their services as fully legitimate. Such brokers will often resort to underhanded tactics to fleece their traders, like tinkering with the prices, inducing slippage or making it difficult for them to withdraw funds.

Furthermore, in this regard it has to be noted that the single market-maker business model, on which most of the CySEC regulated brokers are based, carries an inherent conflict of interest. When trading with such brokers, traders effectively go up against "the house", on a playing field entirely controlled by the latter. See: How do binary options brokers make money?

The return rates offered by some binary option brokers are simply too small, so they cannot be overcome through strategy.

Daweda has come up with a solution for traders to trade against their peirs rather than against their broker. They offer an exchange based model for trading binary options against other traders. Read more >>

What's a good broker?

What should traders look for in a binary option broker? The first step is to check for a license/regulatory framework. One should avoid unregulated brokers without any further consideration, regardless of how good a deal they offer.

CySEC (the Cyprus Securities and Exchange Commission) is one of the best known regulatory authorities, but Australia's ASIC and the UK's FSA are in this game too, together with other national financial regulatory bodies.

The business model pushed by the broker is an important factor to consider too. In this regard, we have two competing models: the above described single market-maker one and the exchange-based one. The two models are fundamentally different. Suffice to say though that with the exchange-based model, traders trade against each-other, while with the single market maker one, they trade against the broker.

The next most important factor is the return percentage. This defines how much one can win on ITM (In The Money) trades, relative to one's initial investment. While some brokers offer as much as 95% average in this regard, others will only provide 70%, or even less, which is something no trader should settle for.

The minimum required deposit is yet another important factor. Most brokers require $250, but there are some outliers who only ask for $100 or even $10. The minimum investment on a single trade is yet another such factor, which will have a massive impact on the way one is able to manage his/her capital. A $1 minimum is desirable in this regard.

The trading platform and the tools it offers is yet another important aspect to consider. Trades need to be placed instantly, without slippage and the platform should deliver the actual market prices, not its own, tweaked numbers. Various charting solutions, copy traders and technical indicators should also be available in the form of trading tools. Other operational facets to consider are underlying asset-selection, option-type selection, expiry times (short as well as long-term options should be available) and support.

There's a reason why we didn't mention bonuses. According to the ESMA's latest directives, regulated binary option brokers aren't allowed to offer their traders bonuses which encourage more trading and additional deposits, or promotions based on such bonuses.

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