Guest post by StartOptions
What are Binary Options? Are they as complex as they sound? How would I get started?
What are Binary Options?
Binary Options are considered by many to be the simplest and easiest way to trade financial instruments. This is perhaps surprising, if judging only by the name ‘Binary Options’ a.k.a. ‘Digital Options’, but names can be misleading. In fact, a much more fitting name would perhaps have been ‘above-below options’ or ‘all-or-nothing options’ because Binary Options offer only 2 possible outcomes: above or below the initial price. This simplified choice of 2 possibilities is the source of the name Binary Options.
Figure 1 shows random outcomes of price evolutions within a 25 minute timeframe, with expiration at time 0 on the right. As figure 1 illustrates, a Binary Option trade expiring at the end of the hour, if placed at a price of 101, can be shown to have a 50-50% of ending above or below the price of 101 at the end of the hour. Therefore, not only is the initial choice binary, having only 2 outcomes- above or below the purchase price, but the outcome also has a binary result- with a 50-50% chance of success of ending above 101, as the 101 line helps to illustrate.
Another important feature of Binary Options which emerges from figure 1 is the notion of option expiration. Unlike traditional options which are worthless at expiration except if realized, Binary Options only attain value at expiration. Again, as the name Binary Options
indicates, the value at expiration can only have 2 possible values- all or nothing. As figure 2 illustrates, the all-or-nothing value of the Binary Options at expiration is divided at the initial price at purchase- the area to the left of 101 is considered ‘out of the money’, and the area to the right of 101 is considered ‘in the money’. Simply put, if your initial assumption that the price at the end of the hour would be above 101, your return on investment would be 100 if the end price at expiration is above 101 or -100 if below 101. For the advanced reader, it is worth noting at this point that many Binary Options vendors offer better return on investment than the one illustrated, although still binary in nature. For example, StartOptions.com will generally return 10% instead of 0% if your trade ended ‘out of the money’.
Figure 1. 1 – Random walks show how Binary Options have a 50-50% chance of ending above-below the strike price
Figure 1.2 – At expiration, your return on investment is also binary in nature, returning all-or-nothing
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