Financial instruments are major driving forces in today’s finances. One of them is what is termed binary options. Binary options carry a high level of risks when it comes to predicting the price of an asset at a given point in time. Binary options are essentially two in nature: the cash-or-nothing option and the asset-or-nothing option. Whichever way if at the maturity date if the price struck at is not reached or the security value is not attained, no binary payoff will be received. Digital options trading as it is conducted today is relatively recent but it’s growing in leaps and bounds.
There was a time when option trading was carried out solely between the issuer and the purchaser. This was largely due to the lack or deficiency of liquid markets where these options could be traded before they would expire. Besides, the official rules and regulations that were used before now hardly applied to options trading. These were therefore known as over-the-counter binary options. They are now distinguished from exchange traded binary options.
Here is the difference between over-the-counter trading and exchange trading. While the former bring into direct relation two parties, the latter requires the existence of well-organized structures and means of trading called exchange.
The advent of the Trading Platforms
The year 2008 was a turning point in the history of fixed return options. Indeed from that time binary options web-sites came up and stepped in to step up exchange-traded all-or-nothing options. This development was timely as it was within the spirit of the Securities and Exchange Commission (SEC)’s decision to allow the listing of cash-or-nothing fixed return options. This was induced by the proposal of the Options Clearing Corporation in 2007 to incorporate binary options within its regulations.
Following the SEC’s move the American Stock Exchange went full length for its first ever exchange-traded cash-or-nothing binary options. These were European style options. What are their characteristics? The major distinctive point of this style is that it can only be exercised at the expiration date. This is in contradistinction with the American style which may be exercised before the expiry date.
Emboldened by the decisions of the first two regulatory institutions, the Chicago Board Options Exchange (CBOE) launched the same type of options in the same year 2008. However in 1973 the same CBOE created the necessary enabling environment for options to be traded. It helped but it was not all-encompassing enough. Besides, it was not open enough for many investors to find their share. But from there investment in options kept advancing till larger and stronger platforms were allowed to come up.
Additionally in 2009 the North American Derivatives Exchange (Nadex) also joined the bandwagon and started offering digital options. Derivatives contracted over-the-counter are extremely juicy: they attract low government taxation and make room for the payment of low fees. Moreover the parties involved can decide to tailor the transactions as they deem fit. Granted that the OTC derivatives have some known edges over the exchange traded derivatives, but Nadex understood the importance of keeping in pace with the dynamism of global finance which has so well accommodated OTC derivatives and given them a choice place in the world of trading.
If the global finance would live up to its name the Internet must be allowed to interfere in the way that binary options trading is done. Thus for a couple of years now many web-sites have been springing up and they offer online opportunities for trading.
According to recent statistics roughly 90 binary option trading platforms are currently running. They set the order of the day by helping to simplify the way exchange traded binary options are being carried out.
Options Payoff Calculations
There are two major perspectives in calculating the payoff in binary options trading. They are tagged vanilla options and exotic options.
In vanilla options the payoff is calculated similarly. Here the binary options are standardized in such a way that there is guarantee of continuous quotations. These options characterize exchange-traded contracts.
In exotic options the payoff is calculated differently. As exotic instruments there was no uniformity to the way the binary options were exercised. Exotic options characterize OTC contracts.
The flexibility involved in binary options trading has made the use of these financial instruments to skyrocket in an extraordinary way. Many are excited at the possibility of trading without the compulsion of going through the drafting and signing of some not-easy-to-figure-out contract. This was not the case with the traditional trading pattern.
Indeed with over-the-counter pattern the investment bank and the clients agree by means of a contract on the modalities of the future settlement of a trade. But online binary options innovated by dispensing traders from formal contract trading. Everybody is welcome but then it will be wiser to come in treading with caution. You need to know the reputation of the brokers as well as the trading firm you are transacting with.
The Future is Here!
The Internet has launched us into that future that we all dreamt of. It has opened up more possibilities for investors in the financial markets. It does not matter where you are in your experience with option trading you now have the awesome opportunity to learn or improve on what you’ve got. The digital option trading has now permeated into several economic and financial sectors. The gaming industry is not spared. In the same vein the predictive markets is making use of the binary options. Fixed-odds gaming is running rampant on the web. It’s got to do with political events, sporting events, weather and others. Technology is the driving force of the digital options trading. And as long as technology keeps developing there seems to be no restraining factor (except change of laws) to the explosion of the trade.
Binary options trading is named so because in this type of trading, there can only be two outcomes; profit or loss. It is a quick, ‘all or nothing’ type of trade, very simple to understand and easy to manage. If a trader uses good binary options strategies, the chances of him getting a good profit are very high.
If a trader thinks that the value of a share will rise, he ‘calls’, and if he thinks that it will fall, he ‘puts’. Let us understand the procedure of binary trading by taking an example. Let us assume, if a trader thinks that the value of a share of Apple Inc. will rise, and end up at $575 at 1400 hours on a certain day, he ‘puts’ and risks $100 for this trade. Now, if the value reaches, or crosses the $575 mark, he will win $100, that is, he will get $200 in return. But if it falls short of the $575 mark, he will lose his money. This is the main concept of binary business.
The deadline time (1400 hours in the above case) is called the ‘expiration date’ or ‘maturity date’. The value which a trader predicts for a stock to rise above ($575 in the above example) is called the ‘strike price’. The biggest advantage of binary business is that, a trader only puts that amount to risk, which he can afford to lose. In the above instance, the trader does not lose more than $100.
Binary Trading through Binary Options Brokers
In most cases, traders execute binary business through a trading company and brokers. Such companies give traders a payoff, if the value terminates above the strike price, which ranges from 70% to 90%. For example, if a binary business firm offers a payoff of 70%, the trader will get $170 from his investment of $100. But if the trader loses, he gets a small rebate (10% in most cases).
In binary trading, the extent to which the value of the share rises does not matter. The trader will get the same amount if it closes exactly on the strike value, or $10 above it.
Types of Binary Options Trading
There are two sorts of binary options; asset or nothing binary option and cash or nothing binary option. The case given above is an example of the cash or nothing binary trading option.
In asset or nothing binary trading option, the trader gets the value, which is equal to the price of the share, if he wins. But if he loses, he loses the amount which he put on risk.