Binary Options Trading

What is the difference between traditional options and Binary Options ?

Traditional options and binary options are actually two very different types of financial instruments, and in many ways the term binary options may be somewhat confusing, as the ‘option’ that gives a traditional option its name is not actually present. Binary options are, however, built on top of traditional options, but their exotic nature removes many aspects of the traditional option to simplify the transaction for the end user.

Both traditional options and binary options are derivatives – which is to say that their value is derived from the value of some other asset. Traditional options, however, confer the actual option to either buy or sell that asset at its strike price. It is this option that gives them their name, and much of the strategy involved in traditional options has to do with whether that option is exercised or whether the option is allowed to expire.

Most traditional options are of a class known as exchange traded options, as well. This means they are actually traded on an official market, and everything is settled through a clearing house, with standardized contracts. While there are a handful of exchange traded binary options, generally when people refer to binary options they are talking about an over-the-counter (OTC) form of binary options, traded between two private parties.

Binary options also do not include the option to purchase or sell the asset itself. The asset is used in a binary option only as a benchmark for the option itself to determine whether the contract has expired in-the-money or out-of-the-money. The underlying asset exists solely as a proxy, and in fact virtually anything could be used as an underlying asset, although most binary options utilize traditional assets that one might also see in a traditional option contract.

Binary options simplify many other aspects of the traditional option as well, which is one reason many people prefer them. While traditional options may have variable contract lengths, where the option can be exercised at any point during the contract, binary options have a fixed contract length, generally around one hour. This removes the need for the trader to ever decide whether they want to exit their contract. Similarly, the potential for profit and loss in a binary option is fixed, unlike a traditional option, where the profit or loss is determined by how much the underlying asset swung in value.

Purchasing a binary option entails simply finding an underlying asset with a contract available, determining whether the value will increase or decrease before the contract expires, and purchasing either a Call or Put option respectively. If at the contract expiry the investor was correct in their prediction, they have finished in-the-money, and receive a fixed payout. If they were incorrect, they have finished out-of-the-money, and suffer a fixed loss. This is incredibly different from a traditional option, in which an investor might purchase an option, and then watch the underlying asset day to day to see how far it shifts, to decide whether they want to exercise their option to either buy or sell the asset.