Binary Options Markets

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Binary Options Markets

The binary options market has evolved greatly since its early beginnings. The market used to be an Over-the-Counter (OTC) instrument that was traded exclusively by high net-worth investors and financial institutions. This was until 2007 when the Securities and Exchange Commission approved proposals to open the market up to the public.

Since then, there has been a transformation in the depth of the market and in how the financial assets are traded. The binary options markets now incorporate trading in almost every financial instrument on the market today.

Market Strategies

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Forex

We have the currency market, popularly called the forex market. Here traders can trade binary bets on the popularly traded currencies in the market. In the last one year, there have been some changes in the forex market, with three interventions in the Japanese Yen by the Bank of Japan. In addition, the Swiss National Bank (SNB) also fixed a minimum exchange rate for the Euro vs. the Confederacio Helvetica Franc (EURCHF) at 1.2000. With statements by both central banks to defend the integrity of the exchange rates of their currencies at all costs, binary bet market brokers have yanked off the Yen crosses and the currency pairs carrying the Swiss Franc from their forex market assets.

Commodities

Virtually every kind of commodity such as corn, coffee, cocoa, soyabeans, natural gas, crude oil and cotton are traded as binary options. The binary bet markets featuring commodities is a fantastic way of playing the commodities market without being unnecessarily exposed to the high-risk and volatile nature of the commodities market. Ordinarily, commodity trading requires a large capital outlay, hefty margin requirements and is extremely volatile. Not many traders can play this market successfully. But the binary bets market provides a low-cost and low-risk way of trading commodities.

Spot Metals

Though sometimes listed under commodities, I usually like to take spot metals differently as they have their own unique trading characteristics. Gold and silver are the popularly traded spot metals. Once again, the binary bet markets offers a low-risk and low-cost way of trading spot gold and silver.

Stock Index Futures

Stock index futures are a great way to play the stock markets. Many traders have lost a lot of money in stocks between 2008 and 2020. Rather than trade individual stocks, why not trade the stock index futures on the binary options markets? Virtually all the major stock indexes can be traded in the binary bets markets. This also offers traders a low-cost way of trading the index futures. Examples of index futures traded are the Dow Jones, Nasdaq, Xetra DAX, IBEX, FTSE100 and Nikkei 225.

Bonds

Many people may not know it, but bonds can also be traded on the binary bets market. You can actually trade individual bonds on the market. One example is the German government bond, which is traded on one of the popular binary options brokerages. The yields of government bonds tend to rise when the economy of the parent country is in trouble, so the news could actually give a trader some hints as to how to play them on the binary bets markets.

Stocks

Blue-chip stocks such as those of Verizon, Apple, Microsoft, Vodafone, Telefonica and British Petroleum (BP) are examples of individual stocks that can be traded as binary options.

The binary bet markets is indeed a huge opportunity that has presented itself for the taking. Perceptive traders can step out of the comfort zone of conventional investment vehicles to take advantage of what the binary bet markets has to offer. Innovations such as the development of the mobile trading platforms have also made it possible to trade binaries on the go. With the uncertainties pervading other markets, the binary bet markets look set to get increased relevance in the financial markets for some time to come.

A Guide to Trading Binary Options in the U.S.

Binary options are financial options that come with one of two payoff options: a fixed amount or nothing at all. That’s why they’re called binary options—because there is no other settlement possible. The premise behind a binary option is a simple yes or no proposition: Will an underlying asset be above a certain price at a certain time?

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Traders place trades based on whether they believe the answer is yes or no, making it one of the simplest financial assets to trade. This simplicity has resulted in broad appeal among traders and newcomers to the financial markets. As simple as it may seem, traders should fully understand how binary options work, what markets and time frames they can trade with binary options, advantages, and disadvantages of these products, and which companies are legally authorized to provide binary options to U.S. residents.

Binary options traded outside the U.S. are typically structured differently than binaries available on U.S. exchanges. When considering speculating or hedging, binary options are an alternative—but only if the trader fully understands the two potential outcomes of these exotic options.

Now that you know some of the basics, read on to find out more about binary options, how they operate, and how you can trade them in the United States.

U.S. Binary Options Explained

Binary options provide a way to trade markets with capped risk and capped profit potential, based on a yes or no proposition.

Let’s take the following question as an example: Will the price of gold be above $1,250 at 1:30 p.m. today?

If you believe it will be, you buy the binary option. If you think gold will be below $1,250 at 1:30 p.m., then you sell this binary option. The price of a binary option is always between $0 and $100, and just like other financial markets, there is a bid and ask price.

The above binary may be trading at $42.50 (bid) and $44.50 (offer) at 1 p.m. If you buy the binary option right then, you will pay $44.50. If you decide to sell right then, you’ll sell at $42.50.

Let’s assume you decide to buy at $44.50. If at 1:30 p.m. the price of gold is above $1,250, your option expires and it becomes worth $100. You make a profit of $100—$44.50 = $55.50 (minus fees). This is called being in the money. But if the price of gold is below $1,250 at 1:30 p.m., the option expires at $0. Therefore you lose the $44.50 invested. This called out of the money.

The bid and offer fluctuate until the option expires. You can close your position at any time before expiry to lock in a profit or a reduce a loss, compared to letting it expire out of the money.

A Zero-Sum Game

Eventually, every option settles at $100 or $0—$100 if the binary option proposition is true and $0 if it turns out to be false. Thus, each binary option has a total value potential of $100, and it is a zero-sum game—what you make, someone else loses, and what you lose, someone else makes.

Each trader must put up the capital for their side of the trade. In the examples above, you purchased an option at $44.50, and someone sold you that option. Your maximum risk is $44.50 if the option settles at $0, and so the trade costs you $44.50. The person who sold to you has a maximum risk of $55.50 if the option settles at $100—$100 – $44.50 = $55.50.

A trader may purchase multiple contracts if desired. Here’s another example:

  • NASDAQ US Tech 100 index > $3,784 (11 a.m.).

The current bid and offer are $74.00 and $80.00, respectively. If you think the index will be above $3,784 at 11 a.m., you buy the binary option at $80, or place a bid at a lower price and hope someone sells to you at that price. If you think the index will be below $3,784 at that time, you sell at $74.00, or place an offer above that price and hope someone buys it from you.

You decide to sell at $74.00, believing the index is going to fall below $3,784 (called the strike price) by 11 a.m. And if you really like the trade, you can sell (or buy) multiple contracts.

Figure 1 shows a trade to sell five contracts (size) at $74.00. The Nadex platform automatically calculates your maximum loss and gain when you create an order, called a ticket.

Nadex Trade Ticket with Max Profit and Max Loss (Figure 1)

What You Need To Know About Binary Options Outside the U.S

Binary options let traders profit from price fluctuations in multiple global markets but it’s important to understand the risks and rewards of these controversial and often-misunderstood financial instruments. Binary options bear little resemblance to traditional options, featuring different payouts, fees, and risks, as well as a unique liquidity structure and investment process.

Binary options traded outside the U.S. are also structured differently than those available on U.S. exchanges. They offer a viable alternative when speculating or hedging but only if the trader fully understands the two potential and opposing outcomes. The Financial Industry Regulatory Authority (FINRA) summed up regulator skepticism about these exotic instruments, advising investors “to be particularly wary of non-U.S. companies that offer binary options trading platforms. These include trading applications with names that often imply an easy path to riches.” 

What Are Binary Options?

Binary options are deceptively simple to understand, making them a popular choice for low-skilled traders. The most commonly traded instrument is a high-low or fixed-return option that provides access to stocks, indices, commodities and foreign exchange. These options have a clearly stated expiration date, time and strike price. If a trader wagers correctly on the market’s direction and price at the time of expiration, he or she is paid a fixed return regardless of how much the instrument has moved since the transaction, while an incorrect wager loses the original investment.

The binary options trader buys a call when bullish on a stock, index, commodity or currency pair, or a put on those instruments when bearish. For a call to make money, the market must trade above the strike price at the expiration time. For a put to make money, the market must trade below the strike price at the expiration time. The strike price, expiration date, payout, and risk are disclosed by the broker when the trade is first established. For most high-low binary options traded outside the U.S., the strike price is the current price or rate of the underlying financial product. Therefore, the trader is wagering whether the price on the expiration date will be higher or lower than the current price.

Binary Options Outside the US

Foreign Versus U.S. Binary Options

Non-U.S. binary options typically have a fixed payout and risk, and are offered by individual brokers rather than directly on an exchange. These brokers profit on the difference between what they pay out on winning trades and what they collect on losing trades. While there are exceptions, these instruments are supposed to be held until expiration in an “all or nothing” payout structure. Foreign brokers are not legally allowed to solicit U.S. residents unless registered with a U.S. regulatory body such as the Securities and Exchange Commission (SEC) or Commodities Futures Trading Commission (CFTC).

The Chicago Board Options Exchange (CBOE) began listing binary options for U.S. residents in 2008.   The SEC regulates the CBOE, which offers investors increased protection compared to over-the-counter markets. Chicago-based Nadex also runs a binary options exchange for U.S. residents, subject to oversight by the CFTC. These options can be traded at any time, with the rate fluctuating between one and 100, based on the current probability of the position finishing in or out of the money. There is full transparency at all times and the trader can take the profit or loss they see on their screen prior to expiration. They can also enter as the rate fluctuates, taking advantage of varying risk-to-reward scenarios, or hold until expiration and close the position with the maximum gain or loss documented at the time of entry. Each trade requires a willing buyer and seller because U.S. binary options trade through an exchange, which makes money through a fee that matches counter-parties.

High-Low Binary Option Example

Your analysis indicates the Standard & Poor’s 500 index will rally for the rest of the trading day and you to buy an index call option. It’s currently trading at 1,800 so you’re wagering the index’s price at expiration will be above that number. Since binary options are available for many time frames—from minutes to months away—you choose an expiration time or date that supports your analysis. You choose an option that expires in 30 minutes, paying out 70% plus your original stake if the S&P 500 is above 1,800 at that time or you lose the entire stake if the S&P 500 is below 1,800. Minimum and maximum investments vary from broker to broker.

Say you invest $100 in the call that expires in 30 minutes. The S&P 500 price at expiration determines whether you make or lose money. The price at expiration may be the last quoted price, or the (bid + ask)/2. Each binary options broker outlines their own expiration price rules. In this case, assume the last quote on the S&P 500 before expiration was 1,802. Therefore, you make a $70 profit (or 70% of $100) and maintain your original $100 investment. If the price finished below 1,800, you would lose your original $100 investment. If the price expires exactly on the strike price, it is common for the trader to receive her/his money back with no profit or loss, although brokers may have different rules. The profit and/or original investment is automatically added to the trader’s account when the position is closed.

Other Types of Binary Options

The example above is for a typical high-low binary option—the most common type of binary option—outside the U.S. International brokers will typically offer several other types of binaries as well. These include “one-touch” options, where the traded instrument needs to touch the strike price just once before expiration to make money. There is a target above and below the current price, so traders can pick which target they believe will be hit before the expiration date/time. Meanwhile, a “range” binary option allows traders to select a price range the asset will trade within until expiration. A payout is received if price stays within the range, while the investment is lost if it exits the range.

As competition in the binary options space heats up, brokers are offering additional products that boast 50% to 500% payouts. While product structures and requirements may change, risk and reward is always known at the trade’s outset, allowing the trader to potentially make more on a position than they lose. Of course, an option offering a 500% payout will be structured in such a way that the probability of winning the payout is very low.

Unlike their U.S. counterparts, some foreign brokers allow traders to exit positions before expiration, but most do not. Exiting a trade before expiration typically results in a lower payout (specified by broker) or small loss, but the trader won’t lose his or her entire investment.

The Upside and Downside

Risk and reward are known in advance, offering a major advantage. There are only two outcomes: Win a fixed amount or lose a fixed amount, and there are generally no commissions or fees. They’re simple to use and there’s only one decision to make: Is the underlying asset going up or down? In addition, there are also no liquidity concerns because the trader doesn’t own the underlying asset and brokers can offer innumerable strike prices and expiration times/dates, which is an attractive feature. The trader can also access multiple asset classes anytime a market is open somewhere in the world.

On the downside, the reward is always less than the risk when playing high-low binary options. As a result, the trader must be right a high percentage of the time to cover inevitable losses. While payout and risk will fluctuate from broker to broker and instrument to instrument, one thing remains constant: Losing trades will cost the trader more than she/he can make on winning trades. Other types of binary options may provide payouts where the reward is potentially greater than the risk but the percentage of winning trades will be lower.

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