Investments in Binary Options

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Binary Option

What is a Binary Option?

A binary option is a financial product where the buyer receives a payout or loses their investment, based on if the option expires in the money. Binary options depend on the outcome of a “yes or no” proposition, hence the name “binary.” Binary options have an expiry date and/or time. At the time of expiry, the price of the underlying asset must be on the correct side of the strike price (based on the trade taken) for the trader to make a profit.

A binary option automatically exercises, meaning the gain or loss on the trade is automatically credited or debited to the trader’s account when the option expires.

Binary Options Outside the US

Basics of a Binary Option

A binary option may be as simple as whether the share price of ABC will be above $25 on April 22, 2020, at 10:45 a.m. The trader makes a decision, either yes (it will be higher) or no (it will be lower).

Let’s say the trader thinks the price will be trading above $25, on that date and time, and is willing to bet $100 on it. If ABC shares trade above $25 at that date and time, the trader receives a payout per the terms agreed. For example, if the payout was 70%, the binary broker credits the trader’s account with $70.

If the price trades below $25 at that date and time, the trader was wrong and loses their $100 investment in the trade.

Key Takeaways

  • Binary options depend on the outcome of a “yes or no” proposition.
  • Traders receive a payout if the binary option expires in the money and incur a loss if it expires out of the money.
  • Binary options set a fixed payout and loss amount.
  • Binary options don’t allow traders to take a position in the underlying security.
  • Most binary options trading occurs outside the United States.

Difference Between Binary and Vanilla Options

A vanilla American option gives the holder the right to buy or sell an underlying asset at a specified price before the expiration date of the option. A European option is the same, except traders can only exercise that right on the expiration date. Vanilla options, or just “options,” provide the buyer with potential ownership of the underlying asset. When buying these options, traders have fixed risk, but profits vary depending on how far the price of the underlying asset moves.

Binary options differ in that they don’t provide the possibility of taking a position in the underlying asset. Binary options typically specify a fixed maximum payout, while maximum risk is limited to the amount invested in the option. Movement in the underlying asset doesn’t affect the payout received or loss incurred.

The profit or loss depends on whether the price of the underlying is on the correct side of the strike price. Some binary options can be closed before expiration, although this typically reduces the payout received (if the option is in the money).

Binary Options and Regulation

Binary options occasionally trade on platforms regulated by the Securities and Exchange Commission (SEC) and other regulatory agencies, but most binary options trading occurs outside the United States and may not be regulated. Unregulated binary options brokers don’t have to meet a particular standard; therefore, investors should be wary of the potential for fraud. Conversely, vanilla options trade on regulated U.S. exchanges and are subject to greater oversight.

Real World Binary Options Example

Nadex is a regulated binary options exchange in the United States. Nadex binary options are based on a “yes or no” proposition and allow traders to exit before expiry. The binary option’s entry price indicates the potential profit or loss, with all options expiring worth $100 or $0.

Let’s assume stock Colgate-Palmolive Co. (CL) is currently trading at $64.75. A binary option has a strike price of $65 and expires tomorrow at 12 p.m. The trader can buy the option for $40. If the price of the stock finishes above $65, the option expires in the money and is worth $100. The trader makes $60 ($100 – $40).

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If the option expires and the price of the Colgate is below $65 (out of the money), the trader loses the $40 they put into the option. The potential profit and loss, combined, always equals $100 with a Nadex binary option.

If the trader wanted to make a more significant investment, he or she could change the number of options traded. For example, selecting three contracts, in this case, would up the risk to $120, and increase the profit potential to $180.

Non-Nadex binary options are similar, except they typically aren’t regulated in the United States, often can’t be exited before expiry, usually have fixed percentage payout for wins (whereas Nadex payouts fluctuate based on the price paid for the option) and may not trade in $100 increments.

Don’t Gamble On Binary Options

There are lots of ways to lose your money in this world but here’s one I hadn’t encountered before: binary option Web sites. They have become popular over the past few years with new ones appearing all the time: anyoption.com, bulloption.com, spotoption.com, binaryoption.com, etc. etc.

The sites appeal to the same type of people who play poker online. But they somehow have an aura of being more respectable because they represent themselves as offering a form of investing. Don’t kid yourself. These are gambling sites, pure and simple. It’s probably just a matter of time before regulators move in on them.

Until that happens, they seem to be doing great business. A Google search for binary option Web sites produced 870,000 hits with promotions like “earn up to 75 per cent every hour” and “81 per cent profit in one hour or less, trade all major markets”. You can buy these options, which are also known as all-or-nothing options, digital options, or Fixed Return Options (FROs), on stocks, commodities, indexes, foreign exchange, and other derivatives.

In fact, you can place a bet (which is what it really amounts to) on just about anything that is publicly traded, depending on which Web site you use (some offer a wider range of choices than others). Some sites provide free guides to binary option trading to get you started.

I was alerted to this phenomenon by a reader who sent me this email:

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“My dad has recently gotten involved with trading binary options online. The basic premise for the site he uses is at a specific time, say 1:25 p.m., you can put down perhaps $100 that XYZ stock will either increase or decrease in price within five minutesby 1:30 p.m. If you are wrong, you get $15 back. If you are right, you win about $70.

“I’ve proven to him that, mathematically, the site has an edge and you must be right 55% of the time in order for your bet to have a neutral expected value. I am also a professional online poker player by trade so I have an extensive understanding of probability, the online gambling markets, and how these sites work.

The problem is he feels he is at a great advantage, citing his ability to read a bunch of charts, follow news, etc. He is a smart man, a former lawyer, and has been following stocks for years, but I feel that he may be overestimating himself here. I’ve looked into online binary options trading a bit and it seems to me that the consensus is that very few people outside of professional traders can beat the trading sites consistently for good money. My dad is up $2,500 or so betting $100 and $50. The best I could do is to warn him about statistical variance affecting his perceived ability and that short-term volatility along with the inherent disadvantage will make consistent winning incredibly hard.

“I’m looking for a way to definitively convince him to stop and that his edge isn’t as great as it seems. I tried talking to him multiple times about the subject but I’m not as knowledgeable about the field and ultimately that becomes my shortcoming when trying to convince him why he shouldn’t continue to be involved with this. Any help would certainly be appreciated.”

I found this correspondence especially fascinating because the writer is a professional online poker player — a gambler by trade. Yet here he is trying to convince his dad that online gambling is a bad thing. I agree, it is. But it’s understandable if the father is skeptical about advice from a son who does the same sort of thing, albeit in a different form.

But that’s for them to sort out. What intrigued me was to discover that binary option trading has become a kind of pseudo investing sub-culture. I went to the site our reader says his dad uses and did some research. It describes binary options as “an exciting new type of investment” — note the use of the word “investment”.

“When a binary option is purchased on our platform, a contract is created that gives the buyer (known here as the investor) the right to buy an underlying asset at a fixed price, within a specified time frame with us, the seller,” the Web site explains. The option must be held until maturity (even if that is five minutes away); unlike regular options it cannot be sold before then.

These sites promote themselves as offering controlled risk (you can’t lose more than a specified amount), low cost, big gains if you guess right, and ease of use — you can trade from home whenever markets are open and set up an account with a credit card.

So what arguments would I use to convince dad to quit? For starters, this sort of thing can quickly become addictive, especially to market junkies. Although the amounts bet may be small, the total can quickly add up if many trades are done in a day. It wouldn’t take long for things to get out of hand.

Second, no one, no matter how knowledgeable, can consistently predict what a stock or commodity will do within a short time frame. Will Apple (AAPL) shares go up or down in the next 10 minutes? Unless there has just been some major announcement from the company, there is no way to even guess at that.

Third, the house definitely has an edge. This particular Web site pays $71 for each successful $100 “trade.” If you lose, you get back $15. Let’s say you make 1,000 “trades” and win 545 of them. Your profit is $38,695. But your 455 losses will cost you $38,675. In other words, you must win 54.5% of the time just to break even.

Finally, these Web sites are unregulated. No securities commission is protecting people’s interests. This is a financial Wild West.

If people want to gamble, that’s their choice. But let’s not confuse that with investing. Binary options are a crapshoot, pure and simple.

How to Invest in Forex and Binary Options in 2020

If you’re interested in investing in Forex and binary options, the large financial currency market, you’re probably wondering which is the best for you to choose.

Below we’ll try to give you a detailed overview of the pros and cons of each one, so you can make a simpler, correct and accurate decision.

How to Invest in Forex and Binary Options DIFFERENCES

Binary options are contracts that have a fixed risk and reward ratio; it’s a market in which the investor is required to predict the direction of an underlying asset within a stipulated period. Binary options are available as commodities, indices, stocks and currency pairs. If the prediction is correct, investors are informed in advance of their reward.

For the Forex currency market, traders are forced to predict not only the direction, but also how high or low the asset will be. Consequently, there’s uncertainty regarding the return and a greater risk.

You should also bear in mind that the forex market doesn’t have a limit on the amount of money an investor can make or lose, unless they are using tools that limit the amount of loss that can be had in a transaction.

This means that the trade will stop automatically if the limit loss occurs. Likewise, the investor can decide how much money he wants to make by setting the value at which he wants to stop trading. For binary options, the maximum amount of investment could be its total amount, while for Forex, the risk can be reduced by using certain programs.

It’s important to note that binary options are actually a new form of investment, while Forex has existed since several currencies came up. Consequently, the Forex currency market is much larger in turnover when compared to the binary options market. Forex is even the largest financial market in the world, working five days a week, 24 hours a day.

Not only that, on average 5 trillion dollars are traded every day, which means that when you invest in Forex and Binary options, you’re basically competing against other professional investors who have a lot of experience. The binary options market is much smaller when compared to Forex, and has a considerably small number of professional investors involved.

To this we must add that investors have many more commercial assets to choose from in comparison with the investors that trade in Forex. Just a few investors know how to use programs like Binary Option Robot, while for Forex investors, highly sophisticated trading software is practically a necessity.

Main reasons to invest in Binary Options

To begin with, with binary options, you have a much wider selection of different commercial assets. In Forex, on the other hand, you only trade with currencies, but in binary options you can market currencies, commodities, stocks, indices and basically anything with a variable value. Therefore, this is only limited by what the investor is willing to select. Unless you only want to exchange currencies, this is a great factor and the main reason to opt for binary options.

Another important thing to note is that in the binary options market, competition isn’t as fierce as it is in Forex. You should bear in mind that the foreign exchange market is huge, so there are many specialized investors with a lot of experience and above all, who are successful in business. In Forex you’ll be competing directly against this type of investors.

The opposite happens in the binary options market where competition is still low. One of the main reasons to opt for various options is that with really large sums, direct investment in equities is cheaper. This offers an excellent opportunity to investors who are investing with small amounts, since tougher competitors are scarce.

On the other hand, a binary options investor gets access to much larger bonds. That is, in the currency market, competition is relatively stable due to its long history. The binary options market is in constant development, which is why new Brokers appear every day trying to attract clients with large and irresistible bonuses and benefits.

In addition to the above, there are no transaction costs in the binary options market; that is, investors pay nothing for the transaction. Expenses are even directly linked to the payment percentage. On the contrary, the costs for foreign exchange transactions can be considerably high, while the minimum costs only allow for small investments, which aren’t really profitable.

Main reasons to invest in Forex

Here we need to note that Forex is a better fit for experienced investors who really know what they’re doing. If you want to invest in currencies based only on your intuition, you will undoubtedly lose your money. People who trade Forex currencies, have extensive experience in the forex market, an experience that comes from years of study and practice.

Also bear in mind that you’ll need skills that can be directly applied to a profitable practice. That is, only theoretical knowledge without application won’t really take you far. Another aspect to consider is that most binary options investors can only invest up to $ 5,000 at the same time.

In Forex, investments worth tens of millions of dollars can be established at a time, which means that with such a large amount, transaction costs will also be proportionally lower than if you’d invested in binary options. Now, if you’re absolutely convinced that you want to invest exclusively in Forex, forex trading is probably your best choice.

In any case, my general recommendation is staring with the binary options by investing small amounts of money and getting the necessary experience and knowledge before venturing fully into currency investing.

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