Binary options are a risky trading strategy.
Often compared to gambling, they can involve a lot of risk for traders who do not understand them and it is easy to take the binary options market for granted, sometimes losing the farm in the process.
That does not mean they do not have any value though. Careful traders can make a profit using binaries, so it is well worth learning about them and understanding exactly how they work. For example, here is how to use binary options if you want to invest in foreign currencies.
(Pro tip: it is always worth knowing more before you trade. See our trading products because, when it comes to your money, it never pays to skimp on getting the right information.)
What are binary options?
Binary options are a specialized subset of options contracts in which you, as an investor, predict whether or not the underlying asset will exceed its strike price by the expiration date.
For example, a binary option could say: “The price of GameCo will exceed $10 on July 1.” If you think that is correct, you buy the option for the stated “offer” price. If you think it is wrong, you sell the option for the stated “bid” price.
The name “binary option” means that the contract has only one of two outcomes.
A binary option is always worth either $0 or $100 at close and is priced based on implied volatility. Your profit in buying a binary contract is the difference between $100 and the contract’s offer price, while your profit in selling a binary contract is the bid.
For example, take the familiar GameCo example and price it at $15 (bid)/$25 (offer). If you buy the contract and GameCo closes above $10 on the expiration date, your profit is $75 ($100 minus the $25 premium). If it closes below $10, you lose the $25.
The reverse holds true for selling the contract. If GameCo closes below $10 on the expiration date and you sold the contract, you keep the $15 as profit. If it expires in the money, you lose $85 ($100 minus the $15 bid price).
What is Forex?
Forex is shorthand for the foreign currency exchange. This is at once simple and deeply complex.
The simple part is this. Forex just means trading foreign currencies against each other. For example, when you trade dollars for euros at the airport, this is a Forex exchange.
At the same time, this market can get complicated fast because there are a lot of ways to trade foreign currencies. For example, you might believe that the euro will appreciate against the dollar. In that case, you could exchange millions of dollars for euros and wait for the euro to gain value.
The rabbit hole goes much deeper, but that is Forex in a nutshell.
What do binary options and Forex trading have to do with each other?
It turns out that Forex traders swap binary options in bets on whether currencies will rise or fall against one another. A (simplified) Forex binary swap would look something like this:
GBP/USD > 1.2900 at 45 (bid)/55 (offer)
This binary option says that by expiration the British pound will be worth more than $1.29 U.S. You can buy this option for $55 or sell it for $45.
Binary Forex moves pretty quickly. Most contracts close within days, or even hours, of purchase. The result is a constant market that tries to pinpoint small fluctuations within the global currency supply.
Now, the point here is not to say that Forex markets are the only or even best place to test drive binary options. However, they are an excellent example of how the so-called “yes/no” option works in practice.
Binaries can work for a well-managed portfolio. Losses are capped and the transaction is simplified relative to predicting a specific strike price. They are, however, notoriously risky largely because they look deceptively simple. Take care and treat them with respect.
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