Binary Options Pros and Cons

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What are Binary Options?

Shanthi Rexaline
Contributor, Benzinga

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Derivative contracts were born because of people’s innate desire to circumvent uncertainty. A derivative contract is a contract drawn up between two parties, the price of which is derived based on an underlying asset.

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The widely-used derivatives include futures, options, swaps, and warrants. A futures contract provides for buying or selling an asset at a predetermined price at a future date, while an option contract allows the purchaser of the option the right to sell or buy a specific asset at a later date at an agreed-upon price.

Apart from the basic, plain vanilla put and call options, variants called exotic options are also available. An exotic option is a little more complex, with special features or pay-off structures intended to meet specific needs of investors.

One example of an exotic option is the binary option.

What are binary options?

Binary options, as the name implies, has two possible outcomes:

  1. The price of the underlying asset finishes either above or below the specified price at the specified time. It can be categorized as one of the simplest financial assets.
  2. Based on a “yes” or “no” proposition, it allows an individual to trade, although the risk, as well as profit potential, are capped.
Binary options basics

Evolution of binary trading options

Binary options became available for retail traders following SEC approval in 2008.

Previously, binary options trading existed but was available only to banks, institutional investors or high net-worth individuals through the over-the-counter market.

In 2007, when the subprime mortgage crisis began to rear its ugly head, the Options Clearing Corporation, or OCC, embarked upon the job of developing regulatory framework for the options market, while also proposing changes to upgrade binary options to the status of a financial asset that could trade as a standalone instrument in major exchanges.

Following SEC approval, the Chicago Board Options Exchange (CBOE) and the American Stock Exchange offered binary options to retail traders. In its early days, binary options came with a lot of restrictions such as the availability of merely call options and options on the S&P 500 Index.

Slowly and steadily, the popularity of binary options increased amid the broadening of the variety of binary options available for trading and the improvement in the trading software that now allows online and mobile app trading.

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Types of binary options

  • High/low option (above/below option): This is the most popular type of binary option. An investor bets on the underlying asset going above or below the predetermined price at the time of expiration.
  • Touch option: An asset will touch the strike price at the time of expiration.
  • Range option : The asset is in a predetermined range by the time of expiration.
  • 60 seconds option: As the name suggests, the 60 seconds option expires in 60 seconds from the time of purchase. A trader in the 60 seconds option should be quick and adequately backed up by a trading software with a best-in-class charting program.

Cash-or-nothing vs. asset-or-nothing

There are two forms of options: cash-or-nothing and asset-or-nothing.

A cash-or-nothing option pays a trader a fixed amount of money or nothing at all, while an asset-or-nothing options also has a fixed payoff but the payoff is equal to the price of the asset.

Other terms

  • Underlying asset: The asset on which the binary option is based upon, or a security used in the binary options contract.
  • Call: An option contract drawn up by a trader who believes the price of the underlying asset will increase by the time the option expires.
  • Put: An option purchased by a trader who believes the price of the underlying security will drop by the time the option expires.
  • Strike price: The price of an underlying asset at the time of the purchase of the binary option, compared against the price of the asset at the time of the expiry of the option.
  • In-the-money, or ITM: An option is in-the-money if a call option’s strike price is below the market price of the underlying asset, or if the strike price of a put option is above the market price of the underlying asset.
  • Out-of-the-money, or OTM: When the strike price of a call option is above the market price of the underlying asset or when the strike price of a put option below the market price of the underlying asset, then the option is out-of-the-money.

Breadth of underlying assets

Binary options provide for trading a host of underlying assets, some of which are:

Binary options example

Assume the bid and ask price of a binary options contract for the EUR-USD currency pair at greater than $1.415 are $30 and $34, respectively. A trader who believes the pair will close above the $1.415 level at 4 p.m. ET, will buy the call option at $34.

Since the option can increase in value to $100 or drop to $0 depending on how the EUR-USD pair moves, a traders makes a profit of $66 (if the pair trades above $1.415 at the specified time) or incurs a loss of $30 (if the pair trades below) $1.415 at the specified time.

Sample binary options trade

The price of the binary option is determined by the market, based on the likelihood of the proposition implied by the contract coming true. If the odds are less, the option price will be low (say $10 or $15).

If you invest $100 in a call option in the S&P 500 Index, which is currently trading at 2,875 (strike price), with an expiration time of 30 minutes, you stand to gain $100, plus a payout (if specified in the contract) if the index is above 2,875 at the expiration time.

The expiration time can be the last traded price or the average of the bid and ask price, depending on the terms set by the broker.

However, if your binary option expires out of the money, or the index is trading below the strike price, you stand to lose your $100.

If the market price is exactly at the strike price at the time of expiration, then you preserve your investment, without any profit.

Advantages to binary options trading

  • You’ll know both the risk and reward in advance, or at the time a contract is struck
  • Binary options expire quickly and can generate substantial returns with a few quick, successful trades. Expiry period could range from 15 minutes to up to a week or two.
  • Investments could be as little as $10.
  • Binary options provide an opportunity to trade with a wide range of assets available all over the world.

Disadvantages of binary options trading

  • Since some of the binary options brokers are loosely regulated, you might face the risk of losing your money if your broker opts to hoodwink you.
  • Since binary options trading is more of a speculative activity, despite the research and analysis going into it, the outcome of the investment is not always a certainty.
  • Earnings potential is limited relative to the movement in the underlying asset. Despite whether an underlying instrument moves $1 or $100 in the desired direction, your return is limited to the price of the binary option.

Brokers that allow binary options

You’ll find that a lot of brokers allow for binary options trading. However, some of them aren’t trustworthy or fall far below the threshold for acceptable brokerages. You can read more about this in our Best Binary Options Brokers guide.

Final thoughts

Since binary options trading comes with its own set of pros and cons, you’ll have to determine if it’s the right way to go for you. After all, limited regulations and limited profit potential can render it an unattractive option. However, there’s no denying of the fact that binary options are an excellent practice ground for a beginner who wants to take the plunge.

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Platform Analysis: Pros and Cons of IQ Option’s Autoclose Feature

Knowing when to take profits isn’t always easy. Technical targets are one method, the autoclose feature is another but both come with risks that can cost you money.

Profit targets or autoclose, you be the judge

Knowing when to take profits isn’t always easy. Technical targets are one method, using an autoclose feature like the one at IQ Option is another. Both methods seek to lock in and maximize profits, but both come with risks. On the one hand a technical target may not be reached, or it may be exceeded, and on the other an autoclose may trigger well before a move is done costing you percentage points of unrealized gains.

Technical Targets – Technical targets are price levels on the charts at which prices can be expected to halt or reverse, or price levels a move is projected to reach based on past price movement. What I can say for these targets is that, over the 12+ years I have been trading and chart watching I’ve seen these targets hit time and time again.

Example of a technical target on the EUR/USD price chart

The only downside is that the time it takes for prices to reach those targets and what happens after they are reached is uncertain at best. This means that successful traders will have to sit and wait, watching for prices to reach their projected levels and decide; do I sell, or do I wait. If you sell you lock in profits and if you wait, you gamble on keeping what you have already worked hard to earn.

The Autoclose Feature – Autoclose is one of the most useful tools of the successful trader. It’s most important function is as a stop-loss. By setting the autoclose to sell out at a loss of 10%, 20% or 30% traders can protect their capital and live to trade again another day. Without it traders risk losing 100% of their trades as they watch prices move in the wrong direction and wrestle with the decision to close out. What many traders do not realize is that the IQ Option autoclose has two settings; the first is for stop-loss, the second is for taking profits.

Pros and Cons

  • Pros of Autoclose – When a trader sets the take-profits to close a trade they are taking all emotion out of the decision. When profits reach a satisfactory amount, the trade is closed no questions asked. This means they don’t have to sit by and watch the trade freeing them up to do other things. Another pro is that it only takes one touch of the target level for the trade to trigger. This means that if prices are volatile and only reach the target level for a brief period the trade will close.
  • Cons of Autoclose – When it comes to auto closure there is only one drawback, it can cost you money. I know that as many times as I’ve seen my profit targets reached I’ve seen them exceeded. This means that potential profits are often far greater than what I think is reasonable to expect. Setting the take-profit may guarantee a portion of the profit but it could cut you off from maximum profits.

How to use the autoclose feature

Using the autoclose feature is very simple. All you must do is set it to the percent of your capital that you want to protect in the event of loss or lock-in in the event of gains. A good rule of thumb for the stop-loss is 3% of the total account. If your total account is $10,000 then 3% of your account is $300 so set the stop-loss on every trade so you lose no more than $300. I like to set it so that my 3% of account is equal to about 30% of the trade. This means, in a $10,000 account, trades of $1000 are acceptable because you will only be losing $300 if it should fail.

Taking profits is a little more difficult but only because you want to lock in the most profits you can. I set my initial profit target at 50%. This means that if the trade should move up quickly and hit 50% I make $500 (assuming the $10,000 account balance). If prices begin to move in my direction but don’t hit my take-profit I then begin to adjust based on market conditions. The first thing to do it too slow raise the stop-loss to lock in more of your capital as the trade moves in your favor. The next thing to do is asses the technical targets for profit and the likelihood they will be reached; if necessary raise the take-profit limit to suit.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.


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Trading Guide: Pros and Cons of Trading Long-Term Binary Options

Long-term binary options may sound an oxymoron, which is why so few offer them. But with some space for analysis

You may know long-term trading by its more common term-investing, a term which is somewhat stranger to the binary options space when thinking about 5 or even 1 minutes expiry options.

Binary options were devised with the idea of exploiting the smallest movements in the market, so it may seem illogical to trade them long-term. However, the same logic makes them more predictable and safer for long-term assumptions, especially for brokers who offer the close before expiry feature.

Consider, for example, trading a yearly Google option that will expire in 10 months. You can wait for Google’s quarterly earnings reports and periodic news announcements, constantly keeping up with the company’s chart to see where they are heading. Such an outlook can provide more data and help in trying to analyze the company’s performance for several months, before the option is no longer available for trading.

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Another important fact is the ability to curb the emotional factor. It is well known that emotions may affect and even harm traders’ decisions, and opting for longer term options leave a smaller room for the “exciting” nature of the intraday binary options trading.

On the other hand, this means that the traders of longer terms options are unable to react to market developments and take advantage of them, as their funds are locked until the expiry.

There are some brokers who offer long-term touch options that can prove useful in situations like this, but they carry an additional amount of risk as well.

Trading long-term binary options is not necessarily better or worse than shorter ones. We can compare the two instruments to a fancy convertible sport car and a sturdy 4×4 vehicle: It does not matter which one you choose, as long as it drives you home.

Best Binary Options Brokers 2020:
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  • Binomo

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