As the name suggests, binary options are stocks that are based on a simple, yes-or-no question: will a given asset rise above a given price at a given time? Stock brokers make trades according to what they believe the answer will be.
This makes trading binary options one of the simplest ways to trade assets and as a result, option trading is popular among both stock market newcomers and seasoned traders.
Though binary stock trading is by far one of the simplest forms of stock trading, it’s important to understand the basics before you get started. If you want to trade, you will need to understand how binary options work, which markets you can trade in, time constraints, which companies are legally permitted to offer binary options in the United States, and the pros and cons of these financial products.
In the United States, binary stock options offer the advantage of capping risk, which comes with capped profit. For instance, a binary stock might ask a trader to consider whether the price of gold will be above $1,275 at 3:30 p.m. today. If the trader believes it will, he or she purchases the binary option. If the trader believes that gold will be lower than $1,275 at 3:30 p.m., he or she will sell the binary option.
Binary options are always priced between $0 and $100. Like other financial markets, there are both bidding and asking prices. Consider that the binary option indicated above is trading at $43 (bid) and $45 (offer) at 3:00 p.m. If you choose to purchase the binary option, you will pay $45. If you choose to sell the binary option you will sell at a price of $43.
Imagine that you buy at $45. When 3:30 p.m. arrives, you find that the price of gold is above $1,275. Your “option” expires, becoming worth $100. This means that you take home a profit of $55 ($100-$45), less any applicable fees. In this instance, you are “in the money.”
On the other hand, if the price of gold is lower than $1,275 at 3:30 p.m., your option expires and is worth $0. You invested $45 and lost $45. In this case, you are “out of the money.”
Bids and offers fluctuate until the stated time of the option’s expiration. You can close your position at any time prior to this expiration in order to ensure a profit or reduce a potential loss.
All options settle at either $0 or $100. That means that each binary option has a potential value of $100. When you make money, someone else loses the same amount. And when you lose money, someone else makes the same amount.
Traders have to front the capital in these trades, and someone has to be selling an option for you to buy one. In this example, the maximum risk is $45 if the option settles at $0. The seller faces a maximum risk of $55 if the option settles at $100.