Binary options are financial instruments that allow you to speculate on the direction of a financial market. The benefits are substantial as your risk management is in embedded into the financial trading instrument. The general idea behind a binary option is that it is an all or nothing proposition and that is why it is called a binary option. Binary means that there are only two outcomes either higher or lower and your bet is based on this premise.
How Binary Options Works
Most binary options are call or put options where the strike price of the binary option is the current value of the underlying instrument. Binary options expire at a specific time on a specific date, and once the option expires, the trade is no longer active. Short term binary options traders are very popular. Many investors like 60 second and 15 minute binary options, because it appears easier to speculate on what is going to happen in the very near future as compared to 1-day or 1-week from now. For example, if someone asked you if it is going to rain you probably have a better chance of being right in the next minute then in a week or a day.
For example, let’s say you are interested in speculating on a rise in the EUR/USD over the next 60 minutes. You can purchase a call binary option when the price of the EUR/USD is 1.12. If the price of the EUR/USD is 1.1201 or higher when the option expires, you receive a payout from your broker. If the price of the EUR/USD is 1.1199 or lower, then you would lose the amount you placed on your binary option trade.
You can also purchase a binary option put which will pay out if the currency pair or security moves lower than your strike price at expiration. Many binary options provide you the opportunity to take profit before the expiration time. Expiration times can vary from 60-seconds to even weekly. Above and below (call and put) binary options are basic binary options and there are other more sophisticated types that investors can trade.
How to Control Your Risk
There are a number of very interesting attributes to binary options, but one of the most important is the embedded risk management features. When you buy a binary option the most you can lose on the trade is the amount you place on the trade. So you cannot lose more than you bet. For example, if the payout on a binary option trade is 85%, for every $100 that you trade, you cannot lose more than the $100 dollars you initially put up for the trade.
Binary option brokers (24option, topoption, fxcm, iFOREX.com etc.) have different minimums trades, but if you only bet $20 dollars on a trade that is the most you can lose. This feature provides substantial risk management. You don’t have to worry about the market moving significantly against you because the most you can lose is the amount you put up to place the trade. Payouts on binary options can also vary depending on your broker.