What are Binary Options?

Binary options have been around for quite a few years with their grand arrival to the financial industry in 2008.  But what is a binary option exactly?  Binary options in fact had been around for many years but were known in those days as over the counter options (OTC).  Options were traded in an old fashioned way by approaching an actual sales man-broker and submitting your options request.  Money physically changed hands and the whole process was man made.  In 2008 digital options were first recognized and approved by the Chicago Board Options Exchange (CBOE) and the SEC as legal tradable contracts.

Portrait by Len by ndanger, on Flickr.  This work is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Today with new technology available and internet accessible everywhere, the OTC options have developed into digital option which are also known as binary options.  Yet what is binary?  Binary stands for 0-1 result, i.e. there are only two possible results for this option; ending the trade in-the-money (win) or ending the trade out-of-the-money (lose).  The all or nothing result is a unique phenomenon you will find when trading digital options.  Traders can potentially make huge profits but can also lose all their investments.

How Does it Work?

So how does this type of investment work?  Binary options trading is based on financial assets price movement and is linked to the stock market.  A trader can basically predict two outcomes for a binary options, Call or Put, High or Low.  By purchasing a Call option a trader is predicting that the price of the underlying asset will rise up to its expiry time.  If the prediction was correct the trader will have made a profit of up to 95% on his initial investment.  Investing in a Put option basically works the same with a small difference regarding the traders prediction, instead of predicting a rise in price the trader will predict a fall and will make the same profit in case of a true prediction.

Let’s try to emphasize this with an example on a binary option on IBM stock.  IBM stock is traded at the New York Stock Exchange at 184.77 points and we have found an IBM option which expires within 30 minutes.  We have created an analysis and are expecting some good news from IBM headquarters and therefore believe that the shares price will rise within our trading period of 30 minutes and therefore have bought a Call binary option on IBM for $200.  Within 30 minutes if the shares price will stand on 184.78 or above we will stay with a profit of about 95% on our investment meaning we will have made $190 in just 30 minutes!  We can also lose most of our money and therefore invested only $200.

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Where is it Going?

Binary options have gained formal recognition in the past few years by several regulators worldwide.  2013 will be remembered as a significant year for binary options as many brokers have applied and have been approved by several European regulators meaning they work under the strict rules of the European Union financial trading rules which means the industry is maturing and this is good news for binary traders.  Regulations mean more legal enforcement which makes binary options trading a safer form of investment.  This is actually a natural path for the growing industry on the way to becoming the next financial hit.