Whether the trader is proved correct or incorrect about a certain price movement, his profit is a fixed amount, regardless of how much the instrument moved. This is a potential downside of binary options, since a regular option would allow the trader to capture a profit based on the instrument's entire movement to the upside or downside.
A binary options trading strategy depends on the market the trader chooses. This fact creates a wide variety of ways to use binary options. When trading the foreign exchange market, for instance, binary options that have hourly strike prices can be used as an excellent substitute for stops, limiting the trader's losses if currency movements turn against him. By the way, all this brokers has hourly strike prices: GToptions, Banc de Binary and 24Options. Importantly, hourly strikes enable the trader to remain in a position if he is convinced that the currency movement is only a temporary reversal. This often happens in foreign exchange, as a long-term trend becomes interrupted by short-term movements in the opposite direction.
All of the above details are complicated because brokers offering binary options often have minimum required investment amounts. These can range from $10 to $10,000, depending on the broker and the particular market. In any case, the rules of the particular binary option determine the trader's profit or loss. It is rare for an option to give 100 percent of the money invested into it back as profit. A portion is kept by the broker as fees or simply operating costs. GToptions and Banc de Binary shares 90% of profit with you, while 24Options shares up to 85%. Usually, a binary option that expires out of the money takes a bigger chunk of the initial investment than a binary option that expires in the money.
Ready to read about BINARY OPTIONS STRATEGY?
A little bit of prehistory
Derivatives have received plenty of criticism for supposedly playing a role in the financial crisis of 2008. A variety of instruments make up the world of derivatives, however, and they cannot all be lumped together in the same group. The only way derivatives can be grouped is in the broadest sense: They derive their value from an underlying asset. Common derivatives include options, futures, forwards and swaps. Options are some of the most popular derivatives available, and investors of all stripes are using them to hedge their risk. An increasing number of traders and investors are switching to options exclusively, abandoning stocks and bonds.
An option gives the right to buy or sell an underlying asset at a specific price on or before a specific time. Options are divided into calls and puts. Calls give the right to buy, and puts give the right to sell. Buyers of calls and puts are not obligated to buy or sell the asset. Sellers of calls and puts are required to sell or buy if the buyer chooses to exercise his right to do so. The strike price is the price the asset must go above (for a call) or below (for a put) in order to be exercised for a profit. The price of an option is called the premium, and it is the total amount of money the investor has at risk when trading options.
A special sub-class of options is called binary options. Technically known as exotic options, binary options modify the basic rules of an options contract. In particular, the profit from a binary option is fixed. The buyer of a binary option will receive a fixed amount of money if the option expires above the strike price (in the money). Alternatively, he will receive nothing at all if the option expires below the strike price (out of the money). Binary options are also referred to as "all-or-nothing options" or "digital options."