There are only two possible directions that the market can go: up or down.
This is the most basic concept behind binary trading options. Being quite simple to understand and use, it’s no wonder why people seeking an additional source of income or intending to try their hand at a potentially rewarding form of trading have found binary options to be their financial instrument of choice. But like any other endeavor that would involve putting your hard-earned money in relative risk, it pays to have a solid knowledge of handling binary options and managing the potential outcomes of this type of trading before plunging headlong into serious and frequent trading.
To give you an idea of what to expect, here are the fundamentals of trading binary options that you should be fully aware of.
What exactly are binary options?
Binary options can also be called “exotic options” (options that are more complex than those traded on an exchange) as well as fixed-return options (because they involve an expiry date or time and a strike price). A trader will speculate on the direction that an asset will take — and there are only two possible outcomes (hence the term binary): the asset will either rise in value or drop in value.
If you correctly speculate on the market at the time of expiry and if the price is on the right side of the strike price, then you stand to receive a fixed return. This return will be yours regardless of how much the asset moved. If you wager incorrectly, on the other hand, then you stand to lose a fixed amount as well — or the entire investment.
Calls and puts
Traders buy a “call” when they believe that the market will be going higher. Conversely, they should purchase a “put” if they think that the market is going lower. The price must be above the strike price at the time of expiry in order for a call to make money; similarly, to make money from a put, the price must below the strike price by the indicated expiry time. Because the movement of the market can cause the payout and risk to fluctuate, different traders can have different payouts, depending on when they enter.
While binary options are indeed simpler in terms of functionality compared to other forms of trading, investors must remain vigilant about studying up on the payouts and risks involved before laying down large amounts of money. One characteristic of binary options that makes them so attractive is that both the reward and risk are known upfront. Generally, there are no fees such as commissions to be paid, and because a trader only speculates on the direction an asset will take instead of actually buying the asset, there are no liquidity concerns to think about. There are only two outcomes to consider — whether the underlying asset will go up or down.
As stated earlier, binary options do not require traders to actually purchase assets, so a downside of trading in this fashion is not having ownership of any significant asset. Another major consideration is that with binary options, rewards often tend to be much less than the risk involved; more money will be lost on losing trades than gained on winning trades. There are also no regulations in place for over the counter markets, so if a trader should fall prey to unscrupulous practices, there are no ways of addressing discrepancies.
Weighing possible outcomes is a primary theme in binary options trading, and as such, traders would do well to pay close attention to the rules of brokers and be fully aware of the risks before starting trades.