What, exactly, are binary options? Are binary options a scam? These and other questions are common these days when talking about online trading options, and for good reason – binary options represent a relatively-exotic and misunderstood form of trading for most investors and traders.
A binary option is a financial instrument that essentially gives you two options (hence the term binary). When you purchase an option, you are basically predicting what a certain asset’s value will do before a certain expiration date (called the expiry). If you are right, you receive a return; if you are wrong, you receive nothing.
Binary options are risky, but they can generate quick returns for savvy investors who know how to make calculated decisions. Here, I’ll explore the world of binary options and explain how they work – as well as address any concerns about being scammed out of your money.
How Binary Options Work
As mentioned above, binary options give you the chance to predict whether an asset’s price will rise or fall by a certain expiry.
The asset in question can be almost anything. There are binary options for stocks, commodities, and foreign currency trading pairs, among others. For example, you can purchase an option on whether or not Google’s stock price will be above or below the given price of, say, $500 per share by the end of December, 2012. ($500 would be called the strike price.) If Google’s stock price is at $501 at expiry, you receive a fixed return. If it is at $499 as the clock strikes midnight on December 31, 2012, you not only lose your money, but also turn back into a pumpkin (if you’re somehow involved with Cinderella.)
When an option finishes how you predicted it would at expiry, the option is in the money. If it isn’t, it is out of the money. It doesn’t matter how far in the money you are; you receive the fixed payout anyway.
Options aren’t horribly complicated. You don’t have to understand advanced indicators and metrics, or work through complex algorithms. In fact, that simplicity is what makes them so attractive to beginning traders and veteran pros alike.
Making Money with Options
How much can you make with options?
The amount you make per option purchase depends on the option’s payout rate. This is generally a percentage of your investment that you’ll receive back, in addition to your full investment.
Let’s say you decide to buy options for Google. You purchase call options, which means you think Google’s price will be above the strike price of $500 by the end of December. The payout rate is 80%. You purchase $1,500 worth of options.
If, at expiry, Google’s price is $500.01 or greater, you will receive 80% of your total investment as profit. That would equal $1,200. (Not bad.)
If, however, Google’s price finished less than $500, you would lose your entire investment of $1,500.
Another way to look at it is this: you will receive a fixed payout that is a percentage of your original investment, with a risk of 100%. This differs from stocks. Stocks theoretically carry a risk of 100%, in that you can lose all your money if the stock goes kaput, but you can control how much you lose when you buy a stock thanks to stop-loss orders. So you may only lose, say, 2%.
The disadvantage of stocks versus binary options, though, is that it’d take a dramatic move to make an 80% profit with an ordinary stock. With a binary option, you can make as high as 90% (the average hovers around 75% on most assets) in one fell swoop.
Plus, some options brokers also pay you a percentage of your investment even if you finish out of the money. This could be anywhere from 5-10% of your investment, so in the unfortunate scenario above, you’d receive $75 to $150 back.
The Importance of Being Careful
Scams, unfortunately, exist with binary options just like any other type of trading (or online financial transaction, really).
The main scam is when beginner traders don’t understand how to navigate the market and wind up buying options from disreputable brokers who aren’t trustworthy. Before you know it, your deposit is gone – or, even worse, your identity is stolen.
That’s why it is crucial to conduct solid research and find brokers who have great reviews and are reputable. Really dig deep and learn as much as you can. As long as you take the necessary precautions, you should be able to find a respected and trustworthy binary options broker for your new-found trading adventures.