Options are often seen as the toys of those with deep enough pockets to afford them and strong enough nerve to know when to get out or ride through the potential for large account drawdown. This often puts them out of sight and mind of most retail traders who find the more manageable risk of spreadbetting, traditional investing and CFD trading far more attractive. The fact that options have almost always been associated with professional, big money traders sets them as the ultimate goal for long term investors who look to buy these with a general idea of the market direction and hope to get out once they find themselves in significant profit. It is true that traditional options, if traded successfully can provide a great risk/reward ratio but the barriers to entry for many smaller traders and those learning the ropes still exist.
This was true of options until the arrival of the binary option, which, I must admit didn’t strike me as an appealing alternative to spreadbetting at first because it continued to use the word ‘option’; conjuring up all of the above problems. However, binary options offer a more flexible and accessible way for investors to purchase options without having the risks associated with the drawdown of the big-money traditional contracts. The principal differences making binary options attractive to smaller traders is that investors of binary options can know in advance precisely how much they stand to gain and lose without going through the emotional torment of this being determined by the price of the underlying asset.
Using the same concept of buying an option, with an expiry date in the future, investors can predetermine their level of profit and loss prior to purchasing the option. This predetermined payout level is a percentage of the initial investment used to purchase the option. Often, this is somewhere in the region of 70-150% of the investment that an investor wishes to put forward. Once the amount has been decided, the predetermined level of payout is agreed and the trade executed, the binary option will either expire ‘in the money’ or ‘out of the money’. This means that it will either close above the price that you bought it, or below, giving binary options the name of ‘all or nothing’ options.
The potential losses are also predetermined and will result in a loss of the initial investment less the protection rate which is often around 15%. Therefore, when a binary option expires ‘out of the money’ the client will have around 15% of the investment credited back to their account. The expiration time on binary options is much shorter than traditional options, allowing an investor to purchase an option which may expire in as little as 5 minutes or up to one month in the future. Binary options expire at intervals throughout the day and this makes them particularly attractive for short term traders.
Therefore, binary options are a much more accessible alternative than traditional options contracts. The level of investment, the payout and the potential losses are all agreed in advance and the expiry time will simply leave the option ‘in the money’ or ‘out of the money’, irrespective of how far the price has moved in your favour or against it. The initial investment level is also far lower than traditional options and a relatively small deposit to cover the potential of your trade is all that is required. Although the expiry time of binary options is set in stone and cannot be changed, the fact that you can purchase binary options with a 5 minute expiry will appeal to medium-term and intraday traders alike.