How to Bet on Binary Options

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Jun 30th, 2010 | By | Category: Featured, Investing Strategies, Options
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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.

Binary Calls

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.

Binary Puts

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!

Sincerely,
Abe Cofnas
Penny Sleuth

June 30, 2010


Author Image for Abe Cofnas

Abe Cofnas

Abe Cofnas has been a full-time analyst of global currency trading for over twenty years and ranks among the top Foreign Exchange (Forex) traders working today. He has written three books on the subject. The most recent, Sentiment Indicators was published in 2010. Cofnas is the managing editor of the Fear & Greed Trader, Agora’s primary source for currencies information. He has also been Futures Magazine’s Forex Trader columnist since 2001, having written over 100 pieces.

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24 comments
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  1. HAVE no EXPERIENCE on forex, nor do i want to, but can these binary options be traded thru my online broker-schwab? Must I open another account with someone called nadex?
    When you lose on a binary call option, do you lose all the premium or just 1.00? If all the premium, i dont see how this differs from normal options-if you are under water or just even, you lose that premium too. If you are slightly profitable, you still might lose money, because you are not ‘in the money’ yet by that premium amount.
    You can see I dont understand-any help will be appeciated. ed

  2. Thank you for the tips. Optionfair is like also a binary option right? I’m just new to option trading and reading a lot on optionfair and binary option. This really help.

  3. Thank you so much for giving a quick idea about the meaning of binary options. I just set up a new category on my website about binary options including a video (http://www.mediafileshare.com/video/435). Your blog enhanced my understanding about binary options and showed me I am on the right track. Thanks again for the great work!

  4. Your method of telling everything in this piece of writing is in fact pleasant, every one
    be capable of easily understand it, Thanks a lot.

  5. Your post is more technical than this intro article i found on financesonline.com:

    http://financesonline.com/bina.....ng-gamble/

    Thanks for the info. I’m trying to take the first step but I’m not too confident I have enough savvy to trade binary options. Your post is an encouraging push into that direction.

  6. […] binary options first become available as a trading method, they were characterized by the higher and lower […]

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  12. Hi Abe, Nadex uses a Spread format like Forex and the new binary options brokers adhere to a “market-maker” format which is basically a variant of an online casino net gaming algorithm. It’s interesting what the regulators will have to say about this. JT

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