There are a variety of methods and options for making investments in assets or markets. They all present different risks and rewards for investors. When stepping into the world of finance its crucial that you know how each option works and how it works for/against you.
Most of the time, financial instruments have a lot of questions that go into evaluating wins and losses. Some can seem downright confusing to most people. Binary options present a much simpler question, yes or no. At its very core that is what binary options boil down to. In this article, we will discuss the basics of binary options, what they are, how to execute them and how you win and lose.
What is a Binary Option?
A binary option is a simple derivative or a financial instrument based on a yes or no question with a predetermined fixed payout or nothing. It is not often you find a financial instrument that shows how much you will win or lose exactly upon purchasing the option.
So, what is the ‘option’ that you are purchasing? Well, each and every binary option starts with one question – will market X be above X price (strike price) at X time? If you say yes then you buy the option, but if you think the answer is no then you sell the option. It seems and honestly, is that easy, but let’s look at an example.
You see the question: Will EUR/USD be above the strike price of 1.18 at 1 P.M. on July 15, 2019? If you have been following the EUR/USD for the last month you would see it has been floating between 1.12 (June 3rd) and 1.13 (June 29th). You might think this option is good for a sell since it does not seem highly likely the EUR/USD pair moves to 1.19.
Another option asks: Will the EUR/USD be above 1.11 on July 15, 2019? The same information we read above would lead you to decide to buy this option as it seems likely for the EUR/USD to hang around the 1.12-1.13 it has been for several months. So, you made your binary option purchase and are now waiting out your options expiration time.
What about the money?
When the binary option closes if you guessed correctly you will receive back your original investment along with a bonus added on top. However, if you guessed incorrectly, then you lose your entire investment. This is the reason so many people liken binary options trading to gambling and also the reason it’s so polarizing. You either win or lose, black or white no shades of gray.
It does help that with most binary options you know exactly how much you will win or lose before every buying the option. If you were to invest $40 hoping to turn it into $100, your option payout, if guessed correctly would be !00$ or $40 original investment + $60 in profits. While your losses would be your entire original investment of $40. With binary options, you can never lose more than you invested, and this is a huge draw for people who have experience with investing and losing beyond their means.
The similarities between betting on sports events and movements of stocks and markets were not missed by governing bodies of the world. This resemblance between the two concepts has caused a very strictly administered regulations by Commodities Future Trading Commission (CFTC). There are sadly a lot of binary options that are considered gambling or fraudulent, so these regulations are highly welcomed by traders.
Regulations (USA vs EU)
The majority of the world’s binary options trading takes place outside of the United States of America. A simple reason for this is the heavy regulations enforced on binary options by the US. People who buy US binary options must do so through a CFTC or SEC-regulated United States exchange. Any illicit provider of binary options is investigated by the FBI. This actually serves the benefit of the trader, because you know that you are not going to be exposed to scams and fraudulent options.
When it comes to Europe, in the past, the regulations came from specific countries’ regulatory bodies like the Cyprus Financial Supervisory Authority (CySEC) and with the regulations of MiFID2. In July 2018, The European Securities and Markets Authority (ESMA) implemented a ban on binary options for retail traders. There are a few good and bad options that are still available to European traders wanting to buy binary options. However, each option has its draws. To trade binary options in Europe you can:
- Purchase alternative products offered by brokers like the IG offering of Knock-outs and IQ Options offering of FX Options. These offerings are not explicitly binary options but they share many traits and strategies.
- Use a Professional Account. This choice is clearly not meant for everyone but if you register as a professional trader, you are assumed to be experienced enough to trade high risk/high reward products like binaries. You must have 2 years of experience to register and have above 500k in trading capital
- Non-EU Branches: this option is for traders whose brokers have brands in several jurisdictions. Say your broker is regulated in the USA through one brand and in Europe through another brand. You can request an account with the Non-EU or off-shore branch of the business and avoid the regulations that are imposed by MiFID in Europe.
Regardless of your location, it is highly recommended that you commit to doing the proper search in the binary option you are purchasing before executing the order. Binary options are a simple and easy way to make and lose money. Taking options from CFTC regulated exchanges allows you to play with your money within the safety of a trustable regulatory body. There are many ways to make money slowly or quickly with binary options but they all come with a clear risk so it is vital to fully educate oneself before investing.
Your capital is hard earned and it should be risked only with confidence. A yes or no question might seem like an easy way to invest but there is a catch. When you think yes and the answer is no, make sure you can afford the risk rather than imagining the reward.