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Step 2 - Decide if price will close higher or lower than current price at the option expiration time which is usually an hour. If we believe the price of the asset will close ABOVE current price at expiry, we want to buy a CALL option. If we believe the price of the asset will close BELOW the current price at expiry, we want to buy a PUT option. Find out which way price action will likely move by looking at this chart example here.
Step 3 - Determine how much we will risk on the position. Could be $50, $100, $500 or any other value depending on our confidence level and risk tolerance.
If we are correct, we are said to be "in-the-money". This would mean with binary options we would receive a predetermined payout of about 70-80% of our original investment.
If the market moves in the opposite direction and we are wrong, then we are "out-of-the-money". This would mean that we would lose all of our investment for that position. (Or in some cases receive 10% of original investment back).
If the asset price on our option closes at the exact same level, we are "at-the-money" and receive our original trading value back with neither profit nor loss.
More information about Binary Options
Binary Options, sometimes called digital or fixed return options, is a simplified yet exciting method of trading the financial markets.
How can binary options trading be so profitable?
Binary options trading is high risk activity based on speculation of market prices driven by near term economic events. Trading in binary options involves high volatility movements and risk of loss. Traders should pursue a responsible and disciplined approach to the market using risk capital only – meaning money that you can afford to lose.
What are the benefits of binary options trading?
Predetermined Risk & Return
Binary options keeps your risk known in advance by trading options that offer pre-determined payouts whether they close "in-the-money" or "out-of-the-money". Binaries offer a lower risk profile than forex trading in that the payout on any option is predetermined, with out-of-the-money trades paying out up to 10% of the original trade. In no case can a trader lose more than his or her original capital.
Profit from Rising & Falling Markets
Binary options are ideal for traders who want to profit from both rising & falling markets. If you believe the price of an asset will rise, buy a call option. If you believe the price of an asset will fall, buy a put option. If your prediction is correct, earn up to 81% profit on your trade.
No leverage or margin to calculate
Unlike forex trading, binary options offers a simpler, pre-determined P&L calculation on every trade.
Profit opportunities in multiple markets
Binary options are traded in multiple markets including forex and shares, commodities like oil futures and market indices. Often times a forex trader will need to endure long periods of relative inactivity and short bursts of trading. Binary options trading is more versatile and therefore offers more opportunities.
Binary options automatically expire at the expiry time of the trade, so there is no need to wait out optimal trades or constantly re-calculate margin, risk and P&L considerations.
It's 1:15pm and EUR/USD currency pair is trading at 1.33680. Positive economic news on US jobs is moving the US dollar up, and you believe that the Euro will fall as investors move their money out of safety and into higher profit US assets. Current payout on the trade is 81%. You believe EUR/USD price will fall below current levels and execute a $100 trade or "Put Option" for 2:00pm expiry. The strike price on the trade is 1.33680. You were right and EUR/USD price closed at 1.33480, below the strike price of 1.33680. In this case the in-the-money payout is 81% of our trade so you win $81:
$100 x .81 = $81
If you were wrong and EUR/USD price closed above the strike price of 1.33680, say 1.33780, you would receive back the out-of-the-money payout of 10%, in this case $10.
100 x .10 = $10
Binary options trading are based on limited risk, meaning in the above example $90 represents the maximum loss on that trade.
1) Current price: the price of the underlying asset.
2) Strike price: the price of the underlying asset when the binary option is purchased.
3) Expiry price: The price of the underlying asset at the time of expiry of the binary option.
4) In-the money: a successful option trade i.e. A CALL option that expired above the option price during purchase or a PUT option that expired below the option price during purchase.
5) At-the-money: an option trade in which the price during expiration is identical to the level at which the option was bought--in such a scenario the initial investment amount is fully returned to the customer.
6) Out-of-the-money: a failed option trade: A CALL option that expired below the option price during purchase, or a PUT option that expired above the option price during purchase.
Binary Options are based on the European method of trading, meaning they cannot close out prior to the option expiry time. The benefit to the trader is that the position closes out automatically; so there is no need to monitor the trade or re-calculate its P&L. Once closed the account balance is updated right away.
For more information about options in general, go here.
A trading example of how to trade a binary option is here.
Return home from how to trade binary options
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