If you’ve spent any time researching (or even partaking) in financial trading activities, you’ll likely have come across the concept of ‘binary options’ contracts.
Colloquially known as ‘exotic’ options, in contrast to ‘vanilla’ options that feature fewer caveats or stipulations within the agreement, binary options are a form of trading contract so-called because the final pay out for the holder is either a fixed monetary sum or nothing at all.
These types of arrangements take various forms, which we’ll examine in more detail below — but first, what do we mean by the term ‘option’ in forex?
How Do Option Contracts Work?
Option contracts grant the holder the ability to either buy or sell an asset for a pre-agreed price at any time before the contract expiry date. It should be noted, however, that there is no obligation to do so — the agreement merely gives that person the option to buy or sell, hence the name!
There are two types of option to choose from depending on your performance predictions for the instrument at hand: a ‘call’ option, which allows you to buy the asset at a predetermined ‘strike’ price, and a ‘put’ option, which lets you sell the asset (again at a fixed strike price).
The purchase price of the option contract itself is dubbed the ‘premium price’; if the contract period expires without you ever triggering the buying or selling option, this is the amount you will effectively forfeit — in real terms, therefore, it also represents the maximum amount you could potentially stand to lose through the option.
Options allow investors to leave themselves an opening for a competitive deal within a particular market without making the entire asset exchange outright; as such, they could be thought of as a simple down payment on a future trade that the speculator can choose to make if and when the market conditions are sufficiently favourable.
Further reading: https://www.investopedia.com/terms/o/optionscontract.asp
What are Binary Options Contracts?
Binary options are a subset of the above contracts that differ from traditional options in two main ways: firstly, the premium price is set by the trader themselves as opposite to the market or broker, and secondly the lifespan of the contract tends to be much shorter — often spanning minutes to days, in contrast to the timeframe of weeks or even years featured in generic options arrangements.
When trading binary options, the broker will agree to pay out a certain percentage of the premium price once the conditions laid out in the initial agreement are met; in practice this is usually if the market price for the instrument meets or exceeds your strike price upon the contract’s expiration. With these agreements, whether the value has moved beyond the strike price by a single pip or several hundred, the trader will be given a fixed amount of profit by the broker at the end of the contract.
Consequently, they’re sometimes known as ‘all-or-nothing’ options as you either receive your predetermined amount or nothing at all (with no bonuses or extra pay-outs for exceeding expectations).
It’s worth noting at this point that the phrase ‘binary option’ is something of an umbrella term that can be used to describe a number of different trade arrangements, which are operate under the same basic principle but differ in unique ways.
Let’s take a look at some of the most common variants in more detail:
How Do Up/Down Binary Options Work?
Also known by such analogous names as ‘above/below’, ‘high/low’ and ‘over/under’ options, ‘up/down’ options are a type of trading arrangement in which the investor simply aims to predict whether the price of the instrument will move up or down before the contract expires.
Up/down options are the simplest form of binary option, whereby traders will purchase a call option if they think the closing price will be above the strike price by the end of the contract period, or alternatively opt for a put option if they feel the final price will be under the product’s initial value.
These agreements typically span the shortest timeframes of any type of options contract — ranging from days to hours and even minutes, as mentioned earlier — and (ostensibly owing to their straightforward nature) usually yield the lowest pay outs to successful speculators, with many brokers offering returns of around 70%-90% of the original stake.
Further reading: https://www.tradingpedia.com/binary-options-predictions
How Do Touch Binary Options Work?
Perhaps more interesting than the above contracts, ‘touch options’ are primarily focused on whether or not the price of the instrument reaches (i.e. ‘touches’) the strike price during the contract period. With these options, the price is permitted to diverge significantly in either direction once the conditions are met without affecting profitability.
A crude analogy for these stipulations would be an athlete running a sprint challenge; once he or she has crossed the finish line, what they do for the rest of the race time is largely irrelevant!
Touch options can be further subdivided into ‘One touch’ options — which as the name implies allow the holder to profit if the agreed strike price is reached at least once, however fleetingly — and ‘no-touch’ options, the exact opposite scenario where investors aim to predict that the price will not cross the agreed strike price for the duration of the contract.
Many brokers also offer ‘double touch’ and ‘double no-touch’ contracts for those who are feeling extra confident, which work under the largely same premise but with two simultaneous strike prices to hit (or indeed avoid)!
As you may have already guessed, touch options tend to work best with highly liquid assets and at times of high volatility, while conversely no-touch options are more suited to instruments that are less susceptible to dramatic shifts in value; in either event, the good news is touch contracts usually offer higher returns than up/down options.
Further reading: https://www.bestfxbrokers.com/binary-trading/trading-school/beginner/touch-no-touch-options/
How Do Range Binary Options Work?
If touch options are like a sprinting race, then ‘range’ options — also sometimes referred to as ‘tunnel’ or ‘boundary’ options — can be thought of as either an old-fashioned wire loop course or a game of Operation; in these contracts, the speculator attempts to predict whether or not the price will break out of a pre-agreed value range.
With ‘in-range’ options, for instance, the market price must stay confined within the two strike prices outlined in the contract (with neither value being equalled at any point) to profit from the trade.
Less commonly, some brokers also offer ‘out of range’ options that allow the holder to profit if the price of the asset gains significant traction in either direction; in these arrangements, the investor will aim for the price to either break below the lower strike price or jump above the higher strike price.
Like no-touch options, in-range contracts lend themselves to periods of calm and consolidation, whereas out-of-range contracts are most likely to turn a profit at times of aggressive market volatility and upheaval — for example, around key fundamental data releases or in the face of unexpected geopolitical developments.
What’s more, whilst seemingly more nuanced and harder to capitalise on in many respects, range options are known for their comparatively high profit margins compared to less demanding types of binary contract; some brokers have been known to grant returns exceeding well over 200%!
Further reading: https://www.binaryoptions.net/range-trading-strategy/
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