Over the past few years, the popularity of traditional options has grown exponentially, as investors have been more willing to experiment with a broader set of investment genres. The market has responded to this more expansive behavior by creating a myriad of new products such as “weeklys” and “minis”, topics Alan has addressed on this site.
Along these same lines, trading foreign currencies has garnered enormous popularity over the past decade, but trading forex is not an easy path to riches by any means. Its risk profile is much higher than for stocks, and a great deal of training, analytical expertise, and experience is necessary, not to mention nerves of steel.
But part-time investors tend to become impatient and are unwilling to invest the time required to be an accomplished and consistent trader. As might be expected under these circumstances, casualties run high, but the marketplace has responded with a much easier instrument for trading – binary options, which are also sometimes called “digital” or “all-or-nothing” options. The back office required to support these options is radically different, and for that reason, you may need another broker to go “binary”.
Traditional options bestow the right to the holder to buy or sell an underlying asset at a point in time, typically the expiration date. Rights and obligations are established and may be sold or liquidated, based on the type of option and exchange rules. Binary options appear to replicate these same conditions. There is an underlying asset, like a currency pair, a commodity, a stock or an index, but no ownership potential is involved. There is an expiration point in time, but most brokers will let you extend that point, too.
Basic example of a trade with binary options
Assume for the moment that you have chosen the “EUR/USD” currency pair as your asset class for trading. Trading is web-based. No downloads are necessary, and the look of the execution platform for binary options is fairly standard in the industry. You will see a chart for the Euro with a line drawn at its current value. An Expiration Time will also be shown. The payoff, typically around 75%, will be prominently displayed, and
you will be asked to bet whether the value will go up (a Call) or down (a Put). The prevailing mix of other customers on this option, whether up or down, will also appear.
All you have to do is enter an amount to wager, pick a direction, and push “Execute”. An “Approve” screen will appear, your final action to place your trade. If you are correct at the expiration point, then your bet and an additional 75% will be credited to your account. If you lose, then you may lose your entire bet, or have a portion refunded. These rules are fixed before you execute your trade. In other words, your risk and rewards are known at the get go. There is no possibility of a margin call. This is a simple “High/Low” example, but most brokers offer a variety of ways to play this game.
More details and a recap about binary options
Binary option websites are cloaked in investment terminology, but the genre is more like a hybrid of trading and gambling. The financial dynamics have improved recently, due to broker competition, such that a 75% reward and a 10% refund, if you guess incorrectly, is the norm for most option classes. You need a “55/45” winning ratio to break even under this type of offering, much the same as with currencies and stocks. The thrill is that you can make a 75% return in a matter of minutes. Try finding that rapid a payoff anywhere else, excluding, perhaps, the lottery or the racetrack.
The broker’s back office is busily calculating the odds, similar to pari-mutuel horserace betting. The odds change right up and until the race starts and is concluded, the expiration time for binaries. There are no fees or commissions. Brokers have factored their needs into the payoff ratios.
Your only test then comes down to deciding if a particular market asset will move up or down in value over a specific time period. For that task, you will still need to recognize patterns, observe indicators, and discern key points of support and resistance, either visually or with Fibonacci tools. Every binary option strategy depends on these three leverage points. Yes, luck is involved, but in trading, you make your own luck by applying analytical skills to bias the odds in your favor.
The advantages of trading with binary options are numerous – simplicity of process, quick turnaround, and a high payoff potential in a short period of time. The cons for this medium are that you must have a desire to speculate, losses can be all or nothing, and unlike American options, you cannot sell or close your position before expiration, although some brokers permit rollover and double-down features.
Trading traditional options may not be for everyone. It is complicated, difficult, and very risky. Binary options, however, dispense with much of the complex infrastructure and allow the investor to focus on one thing, the direction of the market. Risks are still high, but rewards can also be high and quick.
Article by Tom Cleveland from forextraders.com. Mr. Cleveland has been writing about investments since 1980 and joined the team at forextraders.com in 2009. Mr. Cleveland’s most notable work on the article’s subject is his binary options series.
Alan on guest bloggers:
As this BCI site has become one of the more popular financial websites (thanks to you), I receive multiple requests every week from outside bloggers to allow their content to be published on our site. The advantage to the guest author is that they benefit from the exposure to the ever-growing BCI community. The advantage to us is that we are exposed to additional content that may add to our investment expertise. Before an article is published on the BCI site from an outside source I read the article and usually edit it and return to the author for final approval. Both parties must be comfortable with the final product. My plan is for me to continue to be the primary source of blog artciles but allow guest features from time to time. I’d like to know how you feel about this. Send your comments to:
Ultimately our members will determine how this matter is handled.
Chart of the week from our Premium Stock Watch List:
Las Vegas: May 14th
Plainview, NY: May 23rd:
This was a light week for economic and an historic week for the Dow (closed above 15,000 for the first time) and the S&P 500 (closed above 1625 for the first time):
- Consumer credit increased by $8 billion in March, less than the $15 billion anticipated. This was the smallest rise in 8 months
- Credit card spending declined by $1.7 billion, the largest decrease since July, 2012 and reversing a 3-month trend
- Long-term debt which includes mortgages is still growing at a rapid pace
- A recent Fannie Mae survey found that more than 50% of Americans expect home prices to rise over the next year. This positive outlook was the first time in the study’s 3-year history where a majority of Americans were bullish on home prices
- Initial jobless claims (a report of the number of individuals who filed for unemployment insurance for the first time the prior week. While the weekly figure indicates trends in the job market, the four-week moving average is considered a truer gauge) for the week ending May 4th came in at 323,000, less than the 335,000 projected
For the week ended May 10, 2013, the S&P 500 Index was up 1% to 1,634 for a year-to-date return—including dividends—of about 15%.
IBD: Confirmed uptrend
BCI: Moderately bullish favoring out-of-the-money strikes 3-to-2.
Thanking all of our members for your incredible support.