What is a Cash-Or-Nothing Call
A cash-or-nothing option is a type of digital option whose payout is fixed after the underlying stock exceeds the predetermined threshold or strike price. 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.
Also called "binary call" or a "digital call."
BREAKING DOWN Cash-Or-Nothing Call
As the name suggests, cash-or-nothing options settle in cash.
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. They also can carry a stigma of being close to a gambling instrument.
Both cash-or-nothing calls and cash-or-nothing puts either pay or they don't pay, hence the term "digital." Standard options pay on a sliding scale so the deeper in the money they move, the higher the payout.
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.
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.