Binary Options Explained
Basic Definitions You Want To Know
For any given binary options trade, you’ll come across several terms that may be unfamiliar to you. It’s important to learn their meanings and commit them to memory. They’re not as complicated as they sound.
Sometimes called the “exercise price,” the strike price refers to the price level of a binary option’s underlying asset. For example, you might buy a call or put option for the EUR/USD at 1.0975. If you’re trading UP/DONW binary options, the strike price is the price you predict the underlying asset will trade above or below upon the contract’s expiration.
This is the point at which the binary option expires. Every contract will have an expiration date and time attached to it. Your hope is that the instrument will be in the money by that point in time.
Entry and Exit Points
These are the points at which a trader considers getting into, or abandoning, a particular contract. They are calculated using technical analysis tools, such as candlestick charts and pivot points. Analysis of a given asset’s price can reveal levels of support or resistance in its general price level, signaling appropriate times to buy or sell.
Risk and Reward
In the context of binary options, risk is a gauge of the trader’s potential loss on a given contract. If a contract requires $100 to execute, the amount of money at risk is $100. It’s worth noting that some binary options brokers offer rebates on out of the money instruments. This reduces the amount of capital at risk. But the principle is still the same.
Reward is the payout for an in the money binary options. You’ll see the payout listed in percentage form or dollar form next to the contract’s price graph. For example, you might see $85 listed near a contract that requires $100 to execute. If the option expires in the money, you’ll receive the $85 payout (an 85 percent return on your $100 investment).
Example of A Winning Binary Options Trade
Suppose the USD/JPY is trading at 113.746 . The broker you’re using to place trades offers a $100 call binary option that pays out $70 if the price of the USD/JPY trades above 113.746 by the time the contract expires. The options expiry time is 5 minutes from present time.
Pause for a moment to review the terms you learned above. The strike price for the contract is 113.746. Its expiry time is in 5 minutes. For simplicity, we’re assuming that technical analysis has shown the entry point for the binary option to be (the current price of the USD/JPY). Your risk is $100, the amount you’re required to post in order to execute the instrument. And finally, your reward is $70 if the contract expires in the money.
Let’s now suppose you execute the binary option. You watch the price of the USD/JPY as it moves up and down during the subsequent 5 minutes. At the end of the 5 minutes, the USD/JPY has climbed to 113.750. Your contract thus expires in the money, and your $70 payout is automatically placed into your trading account. You’ve made a fast 70% return on your investment and can now look for other contracts to trade.
Example Of A Losing Binary Options Trade
As simple as it seems to make a profit with binary options trading, you can lose money. There is risk involved just as there is with any type of financial instrument. The advantage is that you’ll know the degree of risk upfront (as we noted earlier).
Let’s use an example to show how a losing trade might occur. Suppose you’re thinking about executing a binary Call option for GBP/USD. The currency pair is trading around 1.2896. With the Broker you are using you place a bet of $100 option that pays an 85 percent return if the price expires in the money.
Now, let’s go through a quick review before moving forward. The strike price for the contract is 1.2896. The expiry is 15 minutes from the moment you execute the trade. The entry point is 1.2896 and your risk is the $100 you’re investing in the option.
Suppose the price of the GBP/USD fails to trade above 1.2896 and the contract expires, and thus your option expires out the money. Rather than receiving a payout, you lose your $100 investment. If the binary options broker offers a rebate, you’ll receive a small percentage of your investment back into your trading account.
All major binary brokers have tutorial on their websites to explain further if necessary. The best one can do is practice on the demo accounts to understand these variables more in dept.