How to Bet on Binary Options
One of the most important developments in recent years is the ability for regular traders to use the tools of the professionals. For options traders, some of the most exciting tools to become available are binary options. Here’s everything you need to know to get started…
Binary options have been around at the institutional level for a while. They are now available on currencies and other instruments at the North American Derivatives Exchange, or Nadex. Anyone can open an account with just $100.
More importantly, Nadex has recently received U.S. Commodity Futures Trading Commission approval to allow Futures Commission Merchants (FCM) to route trades through it. This will enable many people to trade Nadex binary options in their regular account, since many brokerage firms are also FCMs.
Binaries cover currencies, commodities and key indexes. I like the fact that the market opens Sunday at 7:45 p.m. EST until Friday at 4:15 p.m. EST. That means you can start trading it at 3 a.m., and that helps keep track of currency markets.
But I’m getting ahead of myself. Let me introduce these powerful, flexible tools to you…
What are Binary Options?
Binaries are options that pay all or nothing. Those are the only two potential outcomes, which is why they called binary options. The central feature distinguishing binary options from regular options is that the payoff is fixed.
In a binary call, it doesn’t matter if the underlying instrument settles way above the strike price, just like it doesn’t matter how far the price falls below a binary put’s strike price. The payoff remains the same, $100 per contract.
A binary call is a bet that the price of the underlying instrument will be ABOVE a strike price. If the trader is correct, then the payoff is $100 per contract. If the trader is wrong, then the payoff is $0.
It couldn’t be simpler — say you expect the GBP-USD exchange rate to be above 1.4860 by 3 p.m. today. Buy a binary call with that strike price and expiration time. If the pair is above 1.4860 by 3 p.m., you’re right, and the binary pays off. If it’s at 1.4860 or below, you get nothing.
A binary put is a bet that the price will be AT OR BELOW a strike price. If the trader is correct, then the payoff is $100 per contract. Again, if the trader is wrong, there is zero return.
Costs of Investing in Binary Options Plays
Nadex charges $1 per contract, though they don’t call it a commission. When putting on a binary call, the trader will pay the offer or ask price. For a binary put, the trader will pay $100 MINUS the bid price.
Nadax offers binary options that expire hourly, daily, and weekly. You do not have to hold the position till the very end, however. You can trade it for a profit or loss at any time until it expires.
The Strategic Benefits of Binary Options
Why am I so excited about binary options? First, it is one of the lowest-cost ways to play options and build your skills. Secondly, their short duration means very quick feedback. But the key benefit is that binary options are like a rebate to your account when you are wrong! In effect, binaries are payouts to you in case you have damage to your account.
Let me show you how this works.
Let’s assume you’re a forex trader with an existing position in a currency pair. Let’s say you purchased a put and bet that the direction was going down. But instead, the market went the other way and your put option is losing value. With regular plain vanilla options, what do you do? The traditional choices are (1) do nothing and hope the market returns in your predicted direction; (2) do nothing and let it expire; (3) close the losing option and save some money.
Often in an option play, there is a period where the option is losing money, but then the market turns around. Many traders who get out then regret doing so. But here is where binaries come in.
For this put example, instead of closing the losing position, you can put on a binary call. You’ll get paid as the market goes north against your regular option. If this sounds exciting, it is!
So, to sum up, binary options open up a world of new investment possibilities. As straight-out trades, they offer quick and low-cost “all or nothing” trades — you don’t need to figure out how far a currency will move… just the minimum you expect it to move.
As hedges, they offer a chance to take in gains even as your other option positions lose money from the same moves. I’ll be filling you in on more about binary options and other opportunities very soon!
June 30, 2010
Start your free Tomorrow in Review email subscription...We Will Not Share Your Email Address
We Value Your Privacy