An option, in general, is a financial instrument which allows its owner to sell or buy a specific asset (i.e. a currency, a stock, etc) at a pre-determined price and at a pre-determined point in the future. In other words, it is a sort of financial agreement which gives its owner the right (but not the obligation) to buy or sell a specific asset.
In 2008 the Chicago stock market in the US witnessed the birth of a new trading instrument based on the concept of options; it gained popularity among traders in no time, mainly due to the fact that it simplified the trading process, while increasing potential profits. Moreover, even novice traders could have a go at the market starting with small investment amounts, in contrast to the tens of thousands of dollars required to participate in classical options markets. This trading instrument was named binary options, and in this article we are going to explain what it is, how it works – and how to earn income from trading binary options.
How do binary options work?
The name itself hints at how binary options function: the word ‘binary’ means ‘something that can be in one of two states’ and is used most often in computer science, where the unit of information – the bit – is represented by a single number which can either be 0 or 1. In case of binary options, which indicates two possible outcomes of any given trade: the option can either expire with a profit or with a loss. When buying or selling a binary option, the trader needs to forecast where the price of the linked asset (which is called “underlying asset” in this case) is expected to go during the lifetime of the contract – if the prediction is correct, the trader will receive a fixed profit, often expressed as a percentage of the initial investment amount; for example, profitability of 75% means that, in addition to your initial investment sum, you will receive three-quarters of it as a profit on a successful trade. In case of a wrong prediction the trader gets back a fraction of the initially invested sum, usually from 5% to 15%.
Let us look at a more detailed example. Imagine that you have analysed the market and determined that the oil price is going to go up within the next hour. Let’s say you decide to use this opportunity and purchase a one-hour “up” binary option on oil for $100 via your broker’s trading platform. The option’s payoff, fixed and known before the deal, is, say, 80%. If, after an hour, the price of oil is by any amount higher than it was when you were opening the trade, you will get back $180 in total. If your prediction turns out to be incorrect and the price of oil actually declines, you will get back $5-$15 depending on your broker’s offer.
The expiration time, i.e. the lifetime of the option, may vary from 30 seconds to up to a year. The trader’s income in case of a correct prediction can go above 90%, with some riskier types of options allowing to make 200% and more on a series of linked trades. However, such level of profitability and convenience comes with a set of responsibilities: one needs to possess the relevant skills and experience, and also be ready to take higher risks.
Lately, many forex traders are choosing to switch to binary options because of higher transparency: the profit levels, as well as possible maximum risks, are known in advance for every particular deal. In addition to that, account management is made easier – you can always determine what the minimum number of successful trades should be in order to ensure stable profitability.
There are four main asset groups that are used as underlying assets for binary options: currency pairs, such as EUR/USD or GBP/USD; commodities, such as oil or gold; stocks of large corporations, such as Microsoft or Apple; as well as stock indices, such as NASDAQ or FTSE. Binary options therefore provide easy access to a wide range of investment instruments, some of which are not available to small investors: for example, if you wish to profit from Apple’s stock price changes, it is not necessary to pay the minimum $5000 to buy Apple stocks directly – you can purchase a $50 binary option on Apple instead, giving you the same results from Apple’s price changes. Some novices compare binary options trading to betting on sports events or even casino games, yet it is important to understand that this instrument has nothing to do with gambling. Financial trading is a craft, not a game, and if you have an intention to obtain stable income, it is important to take it seriously and work on your trading skills.
Where can I trade?
Just like with any other financial product, there are many brokerage companies that offer their specialized platforms for binary options trading. Before opening a trading account, it is important to choose a reliable broker with a good reputation. Many large brokers offer demo accounts to novice traders, where they can gain the necessary experience without risking real money. Such accounts are also aimed at helping traders to get themselves acquainted with the broker’s trading platform.
Not all brokerage companies are punctual and efficient when it comes to depositing and withdrawing funds, which is why it is highly recommended to consider only companies with solid reputation that have licences from at least one national financial regulatory body. It is also a good idea to read trader reviews and feedback on your chosen brokerage company before committing your own money.
How do I make money?
There are hundreds of books and articles written on the topic of trading and predicting asset price movements. At a glance, one might think that binary options trade is an easy task: you press one of the two buttons and get an impressive income at the end of the deal. In reality, it is not that simple at all. In order to make sure that your income is steady and you are making profit and will continue doing so in the long run, you will need to obtain the relevant skills and knowledge as well as choose a trading strategy that works for you. There is a great number of various trading strategies described on the internet, some of which are more effective than others. You can choose one of them and then make it work for you, or build your own strategy from scratch using your own knowledge and experience. It is always a good idea to test a newly created strategy using a demo account to determine its strengths and weaknesses without risking to lose real funds.
Apart from your own market forecasts, you can refer to analyst commentaries, read topical blogs, follow the best traders on Twitter, and otherwise enrich your view of the market with expert opinions. The market changes every day, and the experience that you gain will help you adapt in each new situation. It is important to understand that just like in any other profession, you need to keep developing and gaining new knowledge and experience in order to stay profitable.
We hope that this article and the advice shared in it will help you to start successfully trading binary options. A stable strategy, self-discipline, and a desire to develop can turn this financial instrument into a stable source of income for you for many years ahead.