High-Low Binary Option
Assume your analysis indicates that the S&P 500 is going to rally for the rest of the afternoon, although you’re not sure by how much. You decide to buy a (binary) call option on the S&P 500 index. Suppose the index is currently at 1,800, so by buying a call option you’re wagering the price at expiry will be above 1,800. Since binary options are available on all sorts of time frames – from minutes to months away – you choose an expiry time (or date) that aligns with your analysis. You choose an option with an 1,800 strike price that expires 30 minutes from now. The option pays you 70% if the S&P 500 is above 1,800 at expiry (30 minutes from now); if the S&P 500 is below 1,800 in 30 minutes, you’ll lose your investment.
You can invest almost any amount, although this will vary from broker to broker. Often there is a minimum such as $10 and a maximum such as $10,000 (check with the broker for specific investment amounts).
Continuing with the example, you invest $100 in the call that expires in 30 minutes. The S&P 500 price at expiry determines whether you make or lose money. The price at expiry may be the last quoted price, or the (bid+ask)/2. Each broker specifies their own expiry price rules.
In this case, assume the last quote on the S&P 500 before expiry was 1,802. Therefore, you make a $70 profit (or 70% of $100) and maintain your original $100 investment. Had the price finished below 1,800, you would lose your $100 investment. If the price had expired exactly on the strike price, it is common for the trader to receive her/his money back with no profit or loss, although each broker may have different rules as it is an over-the-counter (OTC) market. The broker transfers profits and losses into and out of the trader’s account automatically.
Other Types of Binary Options
One touch Option : This type of option pays out an investor’s profit once the price of the underlying asset reaches a predetermined barrier, also known as a “trigger”. Once the trigger level has been reached, the trader will receive his payout.
No touch Option : The no-touch option works in the opposite fashion to one-touch options. Here you wager that the underlying asset will not reach a certain price level. Just like the one-touch option, you, or your broker, selects a certain price level above or below the spot (current) price and bet that the price will not reach the determined level within the expiration period.
Double one touch Option: Double one-touch options follow the same logic as one-touch options. However, here we have two triggers, one of each side of the spot price. Your option will become “in-the-money” if the price of the underlying asset breaks through one of the triggers, no matter which one.
For example, if gold currently trades at $1 300, and you, or your broker, have set the upper trigger at $1 350 and the lower trigger at $1 250, your option will be profitable if gold either rises to $1 350, or falls to $1 250. Conversely, if the price fails to touch any of the two triggers through the expiry time, it will become “out-of-the-money”.
Double no touch Option: Double no-touch options follow exactly the opposite principle compared to the double-touch options. Here we have two triggers as well, but for the option to be “in-the-money” the underlying asset’s price shouldn’t reach either of them during the expiration period.
Paired Options:They are offered only by some brokers and basically are based on the performance of one asset relative to another. Here the trader chooses a pair of assets from a list and bets which asset will outperform the other during the selected period. Assets are paired according to their class and sector (these categories must match).
Range binary options: Traders select a price range the asset will trade within until expiry. If the price stays within the range selected, a payout is received. If the price moves out of the specified range, then the investment is lost.
As competition in the binary options space ramps up, brokers are offering more and more binary option products. While the structure of the product may change, risk and reward is always known at the trade’s outset.
Binary option innovation has led to options that offer 50% to 500% fixed payouts. This allows traders to potentially make more on a trade than they lose – a better reward:risk ratio – though if an option is offering a 500% payout, it is likely structured in such a way that the probability of winning that payout is quite low.
Some foreign brokers allow traders to exit trades before the binary option expires, but most do not. Exiting a trade before expiry typically results in a lower payout (specified by broker) or small loss, but the trader won’t lose his or her entire investment.