Binary options is a way of trading based on a single question: will this currency pair or this stock or this commodity be above this price or below? On a certain date. The date is called the expiration date.
Here we explain a little more about how binary options work, in a very simple way: Steve has been keeping an eye on the price of gold for more than a month and although the price of gold is currently, say, $ 1,950, Steve believes that the price will rise and be above $ 2,116 by the end of this month. With regular investments, what Steve should do is buy gold or some alternative to gold, such as an ETF or futures contracts (also known as “Futures”). However, with binary options, Steve can simply (try) predicting that the price of gold will be higher than $ 2,116 by the end of this month. Without having to buy gold.
With binary options there are only two possible results on the expiration date: the price, for example, in this case of gold, will be higher than the price stipulated by Steve (on the date also stipulated by Steve) or the price will not be higher.
Let’s go back to the example, so Steve believes that the price of gold will be higher than $ 2,116 by the end of the month. Steve decides to buy gold at $ 2,116 through binary options. Conversely, if Steve believed that the price would hit $ 2,116 (not that it would be higher, but that it would hit $ 2,116) he would do the opposite and sell gold at $ 2,116 through binary options.
The transaction price in the binary options ranges from $ 0 to $ 100, based on the probability that that asset (in this case, gold) expires at the price or above the price, in this case $ 2,116, on the stipulated date. In this case, the probability of gold reaching $ 2,116 is, let’s say 60%, so the option sells for approximately $ 26. The probability is determined according to different variables, some of them are: how the price has fluctuated in recent times, volatility of the product, the time until the expiration date and the general market opinion about the financial product and its price.
Steve decides to buy 5 contracts at $ 60, so the initial cost for this would be $ 300. The maximum risk of the operation to reach a profit of up to $ 200 until the stipulated date, in this case, until the end of the month.
Steve’s omen came true, he was right and the price was over $ 2,116, in this case, Steve will earn $ 40 per contract, and in total he will have $ 200 profit. Since the expiration date will be $ 500 less the $ 300 initial cost, having a total of $ 200 in earnings. On the other hand, if the price of gold had not been higher than the $ 2,116 that Steve mentioned, Steve would have lost his entire $ 300 investment in the trade.
What are some of the advantages and disadvantages of binary options?
One of the benefits of binary options is that they can be much cheaper and potentially much more lucrative than the other alternatives. For example, to buy an ounce of gold, Steve would have had to pay $ 1,950, and Steve’s return with binary options was 67%, although the price of gold was only up 8.3%. In this example, binary options are more lucrative.
Of course they also have a negative side, that is, binary options also have great risk. If Steve had bought an ounce of gold and the price had not reached the price by the end of the month, he would still have his ounce of gold. In the case of binary options Steve would be left with nothing more than a loss of $ 300.
What do you think of binary options?