Introduction to Binary Option Trading

By June 17, 2016Uncategorized

The Benefits

  • You can make a small bet and try for a large profit
  • Your loss never exceeds your bet
  • You never get stopped out
  • Don’t have to watch the market
  • Your trade “takes care of itself”
  • Possible to trade a quiet market (“off hours”)
  • Can safely trades the news

How Binary Options Work

  • You choose a currency pair: EURUSD
  • You choose a “strike price”: 1.1300
  • You choose an “expiration time”: 11am
  • You make a bet on whether EURUSD will be above or below 1.1300 at 11am
  • The cost of your bet can be as little as $4.00
  • If you’re correct you “win” and you get the payoff which is always $100.00
  • If you’re incorrect you “lose” and get nothing
  • It’s “all or nothing”; “yes or no”

Here Are Some Bet Choices

  • First of all, a reminder: a winning bet always pays off $100.00
  • A “longshot” bet costs as little as $4.00
  • A “50/50 chance” bet costs $55.00
  • You can choose a “longshot” bet, a “50/50” bet or anything in between
  • You can even choose a “favorite” bet which will cost more than $55.00
  • Whatever bet you make, the payoff if you “win” will always be $100.00
  • Your profit on a winning bet equals $100.00 less your bet cost
  • If you “lose” you get nothing and you lost the cost of your bet

“Longshot” Bet Example

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1275 at 11am
  • The bet costs you $4.00 (for a chance to win $100.00)
  • You win $100.00 if EURUSD is above 1.1275 at 11am
  • You lose $4.00 if EURUSD is not above 1.1275 at 11am

“50/50 Chance” Bet Example

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1200 at 11am
  • The bet costs you $55.00 (for a chance to win $100.00)
  • You win $100.00 if EURUSD is above 1.1200 at 11am
  • You lose $55.00 if EURUSD is not above 1.1200 at 11am

“In Between” Bet Example

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1220 at 11am
  • The bet costs you $20.00 (for a chance to win $100.00)
  • You win $100.00 if EURUSD is above 1.1220 at 11am
  • You lose $20.00 if EURUSD is not above 1.1220 at 11am

“Favorite” Bet Example

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1190 at 11am
  • The bet costs you $65.00 (for a chance to win $100.00)
  • You win $100.00 if EURUSD is above 1.1190 at 11am
  • You lose $65.00 if EURUSD is not above 1.1190 at 11am

Closing Your Trade Before Expiration

So far we have focused on putting on the bet and holding it to expiration (when the time is up and your “win or loss” result is determined). You can close your bet at any time right up to expiration, provided your bet has some value left.

Example of Closing Your Trade Before Expiration

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1220 at 11am
  • The bet costs you $20.00 (for a chance to win $100.00)
  • It’s 10:30am and EURUSD is trading at 1.1220
  • Your bet is now worth $45.00; you sell it for $45.00
  • Your bet cost was $20.00 and you sold it for $45.00, a profit of $25.00

Example of Not Being Able to Close Your Trade Before Expiration

  • It’s 10am and EURUSD is trading at 1.1200
  • Your bet is EURUSD will be above 1.1220 at 11am
  • The bet costs you $20.00 (for a chance to win $100.00)
  • It’s 10:30am and EURUSD is trading at 1.1120
  • Your bet is now worth $0.00; there is no close out available
  • Your option is worth $0.00 because the chances of closing above 1.1200 is so low that nobody is willing to take that bet at any price, not even $1.00

Let’s Talk About How the Bet Price is Determined

  • It’s based upon the likelihood of the bet being a winner (paying off $100.00)
  • The two key factors are
    1. Is the bet “in the money” meaning if your bet ended right now you would win the $100.00 or “out of the money” meaning if your bet ended right now you would not win the $100.00. Of course how many pips “in the money” or how many pips “out of the money” affects the bet price as well.
    2. How much time is left (how much time does an “in the money option” ($100,00 payoff) have to become an “out of the money” option (no $100.00 payoff).

Example of “Deep in the Money” Option Close to Expiration

  • You made a bet that EURUSD would be above 1.1220 at 11am
  • It’s 10:55am and EURUSD is trading at 1.1275
  • Your chances of winning ($100.00) is close to 100%
  • Your bet can be sold for $97.00
  • The market makers will buy your winning bet from you very close to full value because it’s a near certainty they will get full value for it

Example of “Deep in the Money” Option Not Close to Expiration

  • You made a bet that EURUSD would be above 1.1220 at 11:00am
  • It’s 5:55am and EURUSD is trading at 1.1275
  • Your chances of winning ($100.00) is very good but there is a lot of time left for that to change
  • The market makers will buy your potential winning bet from you for a good price; roughly $75.00
  • If the price is still at around 1.1275 (deep in the money) at 10:30am, the market makers would buy your potential winning bet for around $92.00
  • The market makers will pay more because the amount of time left for the EURUSD pair to decline to 1.1220 is much less and therefore much less likely.

Example of “Deep out of the Money” Option Close to Expiration

  • You made a bet that EURUSD would be above 1.1220 at 11am
  • It’s 10:55am and EURUSD is trading at 1.1150
  • Your chances of winning ($100.00) is close to 0%
  • Your bet cannot be sold because the market makers feel it has no chance of winning and therefore not worth buying from you at any price.

Example of “Deep out the Money” Option Not Close to Expiration

  • You made a bet that EURUSD would be above 1.1220 at 11:00am
  • It’s 5:55am and EURUSD is trading at 1.1150
  • Your chances of winning ($100.00) is not very good but there is a lot of time left for that to change
  • The market makers will buy your potential winning bet from you for a low price; roughly $15.00
  • If the price is still at around 1.1150 (deep out of the money) at 10:30am, the market makers would not buy your bet from you at any price because they feel it has no chance and therefore no value

Recap

  • The two conditions that might cause a bet to win or lose and therefore have an ongoing impact on the current bet price are:
    1. In the money (win); out of the money (lose)
    2. Time to expiration

Caveats

  • Wide spreads are common in binary options
  • Must be factored into the trade decision process
  • Binary options are a good trading tool if done properly
  • Most people lose at binary options because they don’t use them smartly