Binary options are considered one of the most basic investments, because the payout is fixed from the start and traders are aware of exactly how much they may profit or lose. That is the reason that binary options are also sometimes referred to as fixed return options (FROs), because of the predetermined and set payout. When choosing a binary option, all the trader does is decide whether they feel the market will take the price of the asset up or down.
In binary options, the risk is limited, but there is a large potential for profit, and this is why this type of investment is so popular.
There are two possibilities for binary options; the call and the put.
- The call option allows traders to buy a contract at a predetermined and fixed amount.
- The put option allows traders to sell a contract at a predetermined and fixed amount.
After that, there are several types of binary options which reflect different conditions set by the trader and buyer.
The One Touch Option
The One Touch is when the trader sets that if the price of the asset involved (such as a currency or commodity) trades at a certain amount, then the trader will receive a set payout. In this case, the trader is aware of all potential profits or losses.
The No-Touch Option
In a No Touch option, the trader will make a profit only if the price of the asset does not reach the determined trigger (or trading price) before the option expires. The important thing to remember with a No Touch option is that payout rates can be smaller if the trigger is far away from the spot rate.
The Double One Touch Option
In this kind of binary option, the trader will set two triggers and will make a predetermined profit if either of these triggers is met. This is usually a good option when there is a lot of volatility on the market, with a lot of ups and downs.
The Double No-Touch Option
This is the opposite of the Double One Touch, where traders profit if neither of the triggers is matched. This is preferable when the market is relatively stable, with few ups and downs. It is also popular when there is a lot of consolidation in the market. Successful options traders use different strategies depending on the market, and will often mix and match, using several option types to minimize risk.
Classifying Binary Options
Binary options have been classified according to the reward involved. They fall into two categories; “cash or nothing” or “asset or nothing”.
- The cash or nothing binary option means that the payout is a predetermined cash amount and if the trade is unsuccessful, the trader gets nothing.
- The asset or nothing binary option means the option pays out the value of the asset involved when a trade is successful, and if it is not, the trader gets nothing.
Another way that binary options are classified is based on whether the trade is European style or American style.
- An American style binary option can be exercised at the moment the strike price is hit.
- A European style binary option is only exercised after the set expiry date, and the security price is compared to the strike price only after this date passes. If the strike price is hit before the set expiry, the trader loses out on potential profits.