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Binary Options Explained – Anatomy Of Binary Option Trade

To the average investor who puts money into mutual funds each month, trading binary options is like voodoo. It’s akin to “magic.” The average investor is aware that people can make money by learning how to place profitable trades, but has no idea how it is done. Even traditional options are mysterious to him, and so he sticks to his mutual funds.

Check out our 60s binary trading crash course for the basics on getting started. It’s a quick read and an even faster trade!

But once binary options are explained to him in simple terms, along with the huge profit potential they offer, he quickly learns that anybody can start trading them. More importantly, anyone can profit from them.

If you’re just starting to explore binary options trading, the above may sound familiar to you. The good news is that, like our mutual fund investor, you can get started quickly and easily. We’ll provide a step-by-step binary options tutorial below. You’ll receive a crash course on key terms you’ll need to know along with a couple of examples that show how trades are executed. Once you’ve digested the tutorial, check out this page and set up a demo trading account to practice with before investing real money.

Binary Options Explained: Beginning Definitions You Want To Know

For any given binary options trade, you’ll come across several terms that may be unfamiliar to you. It’s important to learn their meanings and commit them to memory. They’re not as complicated as they sound.

Strike Price

Sometimes called the “exercise price,” the strike price refers to the price level of a binary option’s underlying asset. For example, you might buy a call or put option for gold at $1,850. If you’re trading a touch binary option, the strike price is the price you predict the underlying asset will reach prior to the contract’s expiration.

Expiry Time

This is the point at which the binary option expires. Every contract will have an expiration date and time attached to it. Your hope is that the instrument will be in the money by that point in time.

Entry And Exit Points

These are the points at which a trader considers getting into, or abandoning, a particular contract. They are calculated using technical analysis tools, such as candlestick charts and pivot points. Analysis of a given asset’s price can reveal levels of support or resistance in its general price level, signaling appropriate times to buy or sell.

Risk And Reward

In the context of binary options, risk is a gauge of the trader’s potential loss on a given contract. If a contract requires $100 to execute, the amount of money at risk is $100. It’s worth noting that some binary options brokers offer rebates on out of the money instruments. This reduces the amount of capital at risk. But the principle is still the same.

Reward is the payout for an in the money binary option. You’ll see the payout listed in percentage form or dollar form next to the contract’s price graph. For example, you might see $85 listed near a contract that requires $100 to execute. If the option expires in the money, you’ll receive the $85 payout (an 85 percent return on your $100 investment).

Trading Binary Options Versus Trading Traditional Options

First, it’s helpful to understand some of the differences between binary options and traditional options. We’ll start there. You’ll notice that binary options are anything but “mysterious.”

At its simplest, an option is a contract. It allows you to buy or sell an asset at a given price within a specific time frame.

With a traditional option, movements in the price of the underlying asset influence the value of the option and the potential return it delivers. Not so with binary options. The potential return, or payout, stays the same regardless of the asset’s price. The instrument either pays out (expires “in the money”) or does not pay out (expires “out of the money”) based on whether you correctly predict the price outcome.

The “fixed payout” feature of binary options is important. It removes a lot of the uncertainty that scares investors away from traditional options.

Another major difference involves how long the options last. A traditional call or put option expires after several weeks (typically, the Saturday following the third Friday of the month). It can be traded before it expires, of course, but the duration of the contract is relatively long. Again, not so with binary options. They usually expire within a day. Some expire in as little as 60 seconds. Check this out for details on 60 second trades.

Yet another difference between traditional and binary options involves the amount of money you stand to win or lose from a given contract. With the former, there’s no way to know for certain. Your precise return – either positive (profit) or negative (loss) – cannot be known prior to selling the option or allowing it to expire. By contrast, you know exactly how much you stand to win or lose when trading binary options. The details are posted by the trade before you execute it.

Example Of A Winning Binary Options Trade

Let’s use an example to put everything we’ve discussed above into action. Suppose gold is selling at $1,800 an ounce. The broker you’re using to place trades offers a $100 call binary option that pays out $85 if the price of gold reaches $1,810 by the time the contract expires. The option’s expiry date is one hour from present time.

Pause for a moment to review the terms you learned above. The strike price for the contract is $1,810. Its expiry time is in one hour. For simplicity, we’re assuming that technical analysis has shown the entry point for the binary option to be $1,800 (the current price of gold). Your risk is $100, the amount you’re required to post in order to execute the instrument. And finally, your reward is $85 if the contract expires in the money.

Let’s now suppose you execute the binary option. You watch the price of gold as it moves up and down during the subsequent 60 minutes. At the end of the hour, gold has climbed to $1,811 per ounce. Your contract thus expires in the money, and your $85 payout is automatically placed into your trading account. You’ve made a fast 85% return on your investment and can now look for other contracts to trade.

Example Of A Losing Binary Options Trade

As simple as it seems to make a profit with binary options trading, you can lose money. There is risk involved just as there is with any type of financial instrument. The advantage is that you’ll know the degree of risk upfront (as we noted earlier).

Let’s use an example to show how a losing trade might occur. Suppose you’re thinking about executing a touch binary option for shares of Google. The current price per share is hovering at $720. The broker you’re using offers a $100 touch option that pays an 81 percent return if the share price hits $722 by the contract’s expiry. The option expires in 15 minutes.

Now, let’s go through a quick review before moving forward. The strike price for the contract is $722. The expiry is 15 minutes from the moment you execute the trade. The entry point is $720 and your risk is the $100 you’re investing in the option.

Suppose the price per share fails to reach $722 before the contract expires, and thus your option expires out the money. Rather than receiving a payout, you lose your $100 investment. If the binary options broker offers a rebate, you’ll receive a small percentage of your investment back into your trading account.

Note how quickly both trades above have occurred. The first trade (gold at $1,800) was completed in an hour. The second trade (Google stock at $720) was completed in 15 minutes. The pace at which you can trade these instruments can be intimidating for a lot of people. However, if you’re an astute trader and diligently follow a trading system using charts to calculate entry and exit points, you can do very well trading binary options.

This video will help you learn more about charts

Remember, there is a risk of loss with every trade you execute. Study your preferred assets, learn what factors influence their prices, and grow accustomed to the binary options trading platforms of your favorite brokers. You may find that getting started, and making a profit, with binary options trading is much simpler than you had imagined.