A binary option, in finance, refers to an option where the payoff is either a specific amount of a particular asset or nothing at all. It is called a binary option because of its binary nature where only two outages are possible. This kind of contract is also known as an all-or-nothing, digital, or fixed return option.
There are basically two types – the cash-or-nothing option that pays a fixed amount of currency if it expires in the money; and the asset-or-nothing option which pays the value of the underlying assets.
This financial instrument is attractive because it is structured in such a way that significant payouts are possible even with seemingly insignificant moves in the market, compared to the standard option where significant market movements typically are required before any payout can happen. The investors get a return in the form of a fixed payout. This is based on whether the market raises above or falls under a given level at a particular time. The buyer can, therefore with a binary option, look for specific payoffs even with minimal movements in the financial instrument.
One of the main benefits of trading binaries is that the traders are not faced with the various issues associated with the traditional stocks and commodities options. Such binary option contracts are usually short-term options that do not carry significant risk. Although digital options do not seem to be enough enough, they are very easy to trade. The market is comparatively easy to understand and a trader can immediately learn the advantages relative to other options markets the moment he decides to deal with these instruments.
To illustrate, if an investor thinks that the price of a traded forex currency pair will rise in the next hour, he can look for an option broker online and choose from the binaries available, and put some money on it, say $ 100. If, for example, he opts for a 70% return on a currency pair which he thinks will gain in the next hour, he will gain $ 70 in profits on top of his original placement of $ 100. However, if the value of the currency pair drops, he will only stand to get 10% of his original investment or less depending on the contract. This type of binary option is called a 'call above' binary.
Another type of options trading in these contracts is known as the hit or miss option. Under this option, individuals or options brokers can specify a time and price range for which the market maker will dictate the cost.
For a more detailed explanation on what these type of instruments can do click on Binary Option – this will also give you an insight into how the currency markets function.
The binary option first appeared in trading platforms in 2008 when it was introduced to the Chicago Board of Exchange (CBOE). The same year, it talked on in the North American Derivatives Exchange (NADEX) platforms. Since then, the face of financial markets was never the same again. These contracts became easily accessible and were deal without very much government regulation (although this is expected to change in the future). The binary option presented a new opportunity for individuals and brokers; and the online platform provided more leeway as they no longer need to physically receive the option contracts to trade, or wait for the trading floor to open.
Source by Richard Challenge