What is a Binary Option?

Binary options have become more popular in recent years largely due to their simplicity and defined risk characteristics. It’s a financial instrument, specifically an option, that either expires in-the-money or out-of-the-money. It can’t do anything else.

Essentially, you are placing a bet with a yes or a no. Binary options have values from 0 to 100. A zero value indicates the option expired out-of-the-money and worthless while a value of 100 indicates the option expired in-the-money.

For example, let’s assume there is a binary option on the price of corn closing above $3.60 at the end of the day session. With one hour until expiration, the price of corn is trading at $3.56. A binary option quote may look something like this:

ZC15>$3.60 (1:15 p.m.)

BUY—-SELL

$30         $70

If you were to buy this binary option, you are betting that the price of corn will be greater than the strike price of $3.60 at expiration. Since the maximum value of the option can only go to 100, you are risking $30 to potentially make $70.

If you were to sell this binary option, you are betting that the price of corn will be less than the strike price of $3.60 at expiration. Since the minimum value of the option can only go to zero, you are risking $70 to potentially make $30.

Binary options can have varying expirations from hours to days to weeks to a year. Binaries are also available for trading on many markets. The Nadex Exchange, for example, lists binary options on stock indexes, currencies, commodities and more.

The same methods that are used for trading other instruments can also be applied to binary options. Technical analysis such as trend lines, patterns, volume studies and more may all potentially be useful.

Perhaps the biggest appeal for trading binaries is their defined risk and low cost of entry. Because a contract can only be worth zero or $100 at expiration, the risk per contract is always limited. You have to have enough funds in your account to cover any potential losses, so there are no margin calls or losses exceeding your account balance.

You can trade a binary option with as little as $100 in your account. In addition to the low  capital requirements, commissions and fees may also be quite reasonable.

Be careful of unregulated companies that charge “juice” on winnings. This “juice” will increase your overall costs and can make it extremely difficult to earn any consistent profits.