Binary Options



Next video:
Loading the player...

A binary option is a type of option where the payoff depends on both the price levels of the strike and the underlying asset, like standard options.

If the underlying market is higher than the strike price of the binary option at expiration, it is considered to be “in the money” or true, and the buyer of the binary option would receive a fixed payout of $100 per contract. If at expiration the underlying market is at or below the strike price of the binary, it is considered “out of the money” or false and the seller of the binary option would receive the $100.00

The binary statement is a simple "yes" or "no" proposition to which you either agree or disagree. If you think "yes, it will happen," you buy the binary. If you disagree and think "no, it won’t happen," you sell the binary.

Unlike standard option contracts, the binary option does not give Mike and Jason the right to buy or sell the underlying asset. At expiration, it’s over! The binary is worth $100 per contract - Who’s right? Mike or Jason?

The binary traded price for Mike and Jason is not the actual price of silver, but rather a weighted dollar value of the fixed $100 payout. The binary pricing will range between 0 and 100 and can be described as being the probability and market perception of whether the binary proposition will be true or false at expiration. Even though the underlying silver futures market is trading for $20.18, the March binary silver option contract to be above $20.40 at 1.30pm tomorrow, is priced at $14/$15. Let’s assume Mike and Jason traded this binary at $14.

The binary pricing constantly changes throughout the duration of the option, which depends on the underlying silver price compared to the strike. Mike is long two contracts at $14; his cost is $28. Jason is short two contracts at $14; his cost is $172, calculated as (100 - 14) x 2. Mike wants the binary price to rally and settle at 100. Jason wants the binary price to sell off and settle at 0.

At 1:30 p.m. tomorrow, the binary expires. If silver remains below $20.40, the settlement price will be 0 and Jason receives $100 for each contract or $200 total. His net profit is $28 (or $200 gross profit – $172 cost of shorting the option), and Mike gets nothing.

On the other hand, if silver rallies and finishes above $20.40 at expiration, the settlement price will be 100 and Mike receives $100 for each contract or $200 total. His net profit is $172 (or $200 gross profit - $28 cost of buying the option), and Jason gets nothing.

Both Jason and Mike have clearly defined risk and payout terms given their market view for silver futures using binary options. The contracts are fully collateralized so each party’s initial cost will be the other party’s net profit at expiration if they are correct.

Binary options offer a multitude of trading opportunity choices ranging from the underlying markets of spot FX, commodity and stock index futures, duration choices of two-hour, one-day and weekly options, as well as a vast array of strike price levels - all with limited risk tailored to your liking.

Futures, options and swaps trading involves risk and is not appropriate for all investors.

Related Articles
  1. Options & Futures

    The Options Premium

    An options premium is the amount of money that investors pay for a call or put option. The two components that affect options pricing are the intrinsic value and time value. Matthew is interested ...
  2. Options & Futures

    Understanding Out Of The Money Options

    Options offer investors a way to leverage their capital for greater investment returns. Find out what out the money means for option investors.
  3. Options & Futures

    In The Money Options

    Options offer investors a way to leverage their capital for greater investment returns. Find out what in the money means for option investors.
  4. Options & Futures

    Explaining The Naked Call

    A naked call is one of the riskier options strategies around. Find out how this strategy works, as well as the potential risks and rewards of using it.
  5. Options & Futures

    Put Option Basics

    Put option allow investors to hedge an investment they own or speculate in an investment they don't own. Find out more about this type of option and how it can work in an investor's favor.
  6. Trading Strategies

    Call Option Basics

    Call options offer investors a way to leverage their capital for greater investment returns. Find out more about these financial contracts and how they work.
  7. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  8. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  9. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  10. Term

    What is Pegging?

    Pegging refers to the practice of fixing one country's currency to that of another country. It also describes a practice in which investors avoid purchasing security shares underlying a put option.
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center