Binary options represent an entirely new vehicle for speculative investment to traders with a high appetite for profit potential. As opposed to so-called “vanilla” options, these derivatives work in a streamlined, straightforward way. In essence, these options are just contracts with specific terms that brokers offer. Those terms, along with how they work to make money, are discussed below.
Binary options offered by brokers are based on things called “underlying assets”. Typically, these are stock indexes, currency exchange rates, or individual stocks. Though the buying of binary options does not affect the underlying asset’s price, the price of that asset at the option’s agreed-upon expiration date determines whether or not the buyer makes money.
There are two basic types of binary options. The first, called a call, is bought when the trader expects the price of that option’s underlying asset to go up. If a given trader expects the price of that option’s underlying asset to fall, they would buy a put.
With each binary option, there are two key pieces of information to remember. First is the strike price. This price level determines whether an option expires in the money or out of the money. Second is the date and time of expiry. With binary options, expiration can be as short as a few minutes and as long as several months. It is up to the buyer to determine the expiration date they prefer.
If the underlying asset’s price levle (or point level for indexes) is above the strike price at a call option’s expiration time, that option expires in the money, and the trader is entitled to a profit. Similarly, a trader who buys a put option makes a profit if the underlying asset’s price is below strike level at expiry. What makes binary options unique is that the profit is set at a predetermined level, no matter how far above or below strike level the underlying asset’s price (or point level) is.
Typically, brokers pay out about 90% of the original investment if an option expires in the money. That is, if a trader buys a $100 call option on Apple stock with a strike price of $350, and the price of Apple stock is higher than $350 at the option’s expiry, then the trader would receive $90 in profit (or $190 credited to their account total). If the option expires out of the money, the trader loses all but about 15% of the original investment. In this case, the trader above would get $15 back if Apple’s stock was below $350 at the time of expiration.