Binary Options Trading 101

Binary Options Trading 101
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A BINARY OPTION ASKS A SIMPLE YES/NO QUESTION: WILL THIS MARKET BE ABOVE THIS PRICE AT THIS TIME? When the trade expires, if you were right about the market’s price, you get the full $100 value. If you were wrong, you’ll get zero. Zero or $100. No other settlement value is possible.

When you enter a trade, you pay some value between zero and $100 based on the probability of the binary option expiring with an answer of “yes.” You also pay a fee of 90 cents per option to enter the trade. If you are right when the option expires, you’ll pay another 90 cents as a settlement fee. If you were wrong, then broker won’t charge you the settlement fee. You can never lose more than you paid. And your maximum profit is $100 minus the amount you paid.

There’s a third way your trade can go. Suppose the option starts moving in your direction and its value goes up, but you aren’t sure it will stay there. Naturally, you might want to just cash out while you can and get some profit. You can do that. You just sell the option if you bought it or buy it back if you sold it.

You can also close your position before expiration if the trade is losing and you don’t want to stay in the trade. Maybe you want to cut your losses rather than risk losing the full amount. Maybe the market just isn’t doing what you thought it would. Whatever the reason, you can exit the trade before expiration.

So the question is a simple yes/no: Will it be or not be above the strike price at the expiration time? There are many ways to trade based on that question. It will take all your trading skill and acumen. But it won’t take more money than you decide to risk up front. Nadex doesn’t issue margin calls, ever. Brokers don’t have to. And you don’t have to worry about getting one. Since both buyer and seller put up their share of the option’s $100 value before entering the trade, it’s fully collateralized, meaning no leveraged debt.

This is a hypothetical example, so broker’ll leave out some of the finer details and focus on the basics. Let’s say you’re looking at a binary option based on the following question: WILL THE EXCHANGE RATE BETWEEN THE EURO CURRENCY AND US DOLLAR BE ABOVE 1.1300 ($1.13 PER EURO) AT 7PM TODAY?

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On the Nadex platform it would be written like this: EUR/USD > 1.1300 (7pm) Now let’s say you buy this binary. That means you think the answer to the question will be “yes.” If you are right, and the spot EUR/USD FX rate is higher than 1.1300 at 7pm (ET), the binary will settle at $100. If not, and the spot EUR/USD FX rate is lower than 1.1300 at 7pm (ET), the binary will settle at zero.

You’re probably wondering, what if the EUR/USD is exactly 1.1300 at 7pm? It will still settle at zero. (See the box to the right to learn how Nadex calculate that final price.) The desired outcome for every binary option is always “greater than,” so both “less than” and “equal to” get the answer “no.” The final price using the settlement calculations noted above creates what is called the settlement value. That’s the price we compare to the strike price, 1.1300, to say whether it is greater than, less than or equal.

IN SHORT, AT EXPIRATION BROKER COMPARE THE SETTLEMENT PRICE OF THE UNDERLYING MARKET TO THE STRIKE PRICE OF THE BINARY OPTION. IF THE MARKET SETTLEMENT IS GREATER, THE BINARY IS WORTH $100. IN ALL OTHER CASES, THE BINARY IS WORTH ZERO.

The calculation doesn’t consider whether the EUR/ USD was higher than 1.1300 at some earlier time. Brokers only look at the 7pm expiration. Since it’s possible for the euro or any market to spend all day above the strike price (1.1300) and then drop just before 7pm, it’s possible for a binary that looked ready to expire at $100 to end up at zero.

That’s one of the challenges of binary options trading but also one of the opportunities. If the market is even a tiny bit above 1.1300 at expiration, you still get the full $100. You get a substantial return on a small margin of difference. This difference is especially powerful in flat markets, where a market might not move up or down very much. With binary options, it doesn’t have to be more than a tick above the strike price for a buyer to get the full $100 payout. That’s because with binary options, as the name implies, it’s all or nothing. Unless you exit early.

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