Binary Option

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DEFINITION of 'Binary Option'

A type of option in which the payoff is structured to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money. The success of a binary option is thus based on a yes/no proposition, hence “binary”. A binary option automatically exercises, meaning the option holder does not have the choice to buy or sell the underlying asset.

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BREAKING DOWN 'Binary Option'

Investors may find binary options attractive because of their apparent simplicity, especially since  the investor must essentially only guess whether something specific will or will not happen. For example, a binary option may be as simple as whether the share price of ABC Company will be above $25 on November 22nd at 10:45 am. If ABC’s share price is $27 at the appointed time, the option automatically exercises and the option holder gets a preset amount of cash.

Binary options are significantly different from vanilla options. They are occasionally traded on platforms regulated by the SEC and other regulatory agencies, but are most likely traded over the Internet on platforms existing outside of regulations. Because these platforms operate outside of regulations, investors are at greater risk of fraud. For example, a binary options trading platform may require the investor to deposit a sum of money to purchase the option. If the option expires out-of-the-money, meaning the investor chose the wrong proposition, the trading platform may take the entire sum of deposited money with no refund provided.  

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RELATED FAQS
  1. What is the history of binary options?

    Binary options trading is option trading for which there are two possible results. A trader purchases an option and at the ... Read Full Answer >>
  2. What are some examples of financial spread betting?

    Financial spread betting is available across a wide array of markets. Financial spread betting is primarily aimed at making ... Read Full Answer >>
  3. Why is the Chicago Board Options Exchange important?

    The Chicago Board Options Exchange (CBOE) was the very first exchange to offer standardized exchange-traded options on stocks. ... Read Full Answer >>
  4. What happens to my call options if the underlying company is bought out?

    Typically, the announcement of a buyout offer by another company is a good thing for shareholders in the company that is ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
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    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>

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