What's the difference between binary options and day trading?

By Jean Folger AAA
A:

Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. A binary option is a type of options in which your profit/loss depends entirely on the outcome of a yes/no market proposition: a binary options trader will either make a fixed profit or a fixed loss. Day trading, on the other hand, is a style of trading in which positions are opened and closed during the same trading session. A day trader's profit or loss depends on a number of factors, including entry price, exit price, and the number of shares, contracts or lots that the trader bought and sold.

An option is a financial derivative that gives the holder the right, but not the obligation, to either buy or sell a fixed amount of a security or other financial asset at an agreed-upon price (the strike price) on or before a specified date. A binary option, however, automatically exercises, so the holder does not have the choice to buy or sell the underlying asset.

Binary options are available on a variety of underlying assets, including stocks, commodities, currencies, indices and even events, such as an upcoming Fed Funds Rate, Jobless Claims and Nonfarm Payrolls announcements. A binary option poses a yes/no question: for example, Will the price of gold be above $1,326 at 1:30 p.m.?  If you think yes, you buy the binary option; if you think no; you sell. The price at which you buy or sell the binary option is not the actual price of gold (in this example) but a value between zero and 100. The trading range fluctuates throughout the day, but always settles at either 100 (if the answer is yes), or zero (if the answer is no). The trader's profit/loss is calculated using the difference between the settlement price (zero or 100) and your opening price (the price at which you bought or sold).

Binary options traders "gamble" on whether or not an asset's price will be above or below a certain amount at a specified time. Day traders also attempt to predict price direction, but profits and losses depend on factors like entry price, exit price, size of the trade, and money management techniques. Like binary options traders, day traders can go into a trade knowing the maximum gain or loss by using profit targets and stop losses. For example, a day trader might enter a trade and set a profit target of $200 and a stop loss of $50. Day traders, however, can "let their profits run" to take full advantage of large price moves. Of course, day traders could also let their losses get out of control by not using stop losses or by holding onto a trade in the hopes that it will change direction. Day traders buy and sell a variety of instruments including stocks, currencies, futures, commodities, indices and ETFs.

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