What is a Cash-Or-Nothing Call?
A cash-or-nothing call is an option that trades on currencies, commodities or OTC securities, and has a binary outcome. It pays out either a fixed amount, if the underlying stock exceeds a predetermined threshold or strike price, or pays out nothing. This kind of option is also known as a binary call or a digital call.
- Cash-or-nothing calls are also known as digital or binary options.
- They pay in full value if a condition is met, or zero if not; there is no partial or multiple payment.
- It is best to trade cash-or-nothing options on exchanges or platforms regulated.
Understanding Cash-Or-Nothing Call
As the name suggests, cash-or-nothing options settle in cash. The buyer pays a premium for the option, and the cash settlement pays out or not. The payout depends only on whether or not the underlying asset closes above the strike price (in the money) at the expiration date. It does not matter how deep in the money as the payout is fixed.
Although all digital options may appear to be simple, they are different from vanilla options and may be traded on unregulated platforms. Therefore, they may carry a higher risk of fraudulent activity. Investors who wish to invest in binary options should use platforms that are regulated by the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) or other regulators.
Binary options also carry a stigma of being like a gambling instrument because they either pay or not and the outcome seems very often left to chance. Standard options pay on a sliding scale so the deeper in the money they move, the higher the payout, and this gives them more of a sense of being an investment or trading vehicle, rather than a betting vehicle, though the distinction is largely more perceived than real.
There are other types of binary options including asset-or-nothing calls and asset-or-nothing puts. However, while the name suggests they settle with physical delivery of the underlying asset, that is not always correct. Depending on the options, the payoff could be the cash price of the underlying asset at expiration. And it is digital, i.e. all or none, so if the underlying price is above the strike price, it pays the underlying price. If it is not above the strike then the payoff is zero.
Example of a Cash-Or-Nothing Call
For example, assume the Standard & Poor's 500 Index (S&P 500 Index) currently trades at 2,090 at 12:45 p.m., on June 2. A trader is bullish on the S&P 500 Index and believes that it will trade above 2,100 before the end of that trading day on June 2. The trader purchases 10 S&P 500 Index 2,100 cash-or-nothing call options at 12:45 p.m. for $50 per contract. If the S&P 500 Index closes above 2,100 at the end of the trading day, on June 2, the trader would receive $100 per contract, or a profit of $50 per contract. Conversely, if the S&P 500 Index closes below 2,100, the trader loses all of his investment, or $500.
Closing just slightly in the money is all the call holder needs to profit. If the trader believes the underlying asset will close significantly higher than the strike price, then standard option may be a better choice since it allows the holder to participate in that gain. The cost should also be lower.
American Style digital option automatically exercise the moment they get in the money, unlike American style standard options. This means that the holder gets the payoff immediately instead of waiting for expiration. This is similar to one-touch options.
European Style digital options only exercise at expiration. Most digital options are in the European Style.