Binary options are similar to regular options in many respects, but with one key difference. Binary options are based on a system where maximum profit and loss are known beforehand. Because of this feature, it is relatively easy to calculate risk and reward for any binary option trade.
Things You'll Need
- Options trading account
Open an account with a broker. If you already have a trading account that allows you to trade normal options, you will probably be able to trade binary options as well.
Choose a binary option market to trade. There are binary options markets for a number of stocks, currencies, indexes and commodities. For example, the Chicago Board Options Exchange offers binary options on the S&P 500 and the CBOE Volatility Index. Other markets to consider include currency pairs like the EUR/USD or commodities such as gold and oil.
Place the trade. As with normal options, buy a call option if you expect the market price to rise, or a put option if you expect the market price to fall. You also need to choose a strike price at which to buy the option. When picking the strike price, choose a price that the market has a realistic chance of surpassing in the time frame of the trade.
Exit the trade. Binary options are so named because, unlike traditional options, they are based on an "all or nothing" payout at expiration. This means that if your binary option expires above its strike price (call), or below its strike price (put), you receive a predetermined payout amount. If the binary option expires out of the money, you lose the premium paid for the option.
Tips & Warnings
- Many popular brokers offer binary options trading, check with your individual broker to make sure they offer binary options trading.
- You do not need to wait until expiration to exit the trade. If the binary option moves past the strike price at any point in the trade, you may exit the trade for a profit. However, the amount you receive will be less than the predetermined payout you stand to receive if the option remains above (call) or below (put) the strike price at expiration.
- Photo Credit finance image by Christopher Hall from Fotolia.com
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