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What are binary options ?
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Before understanding what are they, let me explain what is an OPTION ?
An OPTION is a contract, to either buy / sell an asset at a specific strike price during a particular period of time expiry or a date. Let me explain in a simpler way how these options are being bought or sold. Are you wondering why these options are called binary options ? Binary, as is in two values and here at binary options trading a trader will be provided with two options to trade. While the classical type of binary options is CALL & PUT option.
Though however there is a detail explanation given about the various types of binary options, we need to look into the classical and most known binary option to give you a basic understanding to understand further. And explaining theCALL/PUT option, if we had opted for “ BUY “ CALL option, then we are expecting the asset price to go HIGH and here we can also “SELL” the same CALL option if we think that the asset price will go LOW and similarly we can“BUY” PUT option if we expect the asset price to go LOW and “SELL” PUT option if we know that asset price is going HIGH.
And one has to remember these two terminologies CALL and PUT options where I will be using these two terms a lot while explaining you how to trade these binary options. Many people generally get confused understanding the difference between CALL and PUT. In other words to explain if am expecting an asset to rise, I will buy a CALL option and if am expecting the same asset to drop I will buy a PUT option.
MARKETS TO TRADE BINARY OPTIONS
Surely now you are very much ready to trade these BINARY OPTIONS, but there is a little bit more to know more about these BINARY OPTIONS. Ever got a doubt how many different assets are available for a trader to trade ? Check out below the list of options,
- European Stocks
- U.S. Stocks
- End of the day
- End of the week
- End of the month
- End of the quarter
HOW TO TRADE BINARY OPTIONS ?
Let’s take an example of a classic BINARY OPTIONS TRADING and explain how the CALL and PUT options are taken,
- Asset : Eur/Usd ( Forex Currency Pair )
- Option : CALL/PUT [ Buy / Sell ]
- Expiry Date : May 30th ( Generally expiries are at the end of the month )
- Strike Price : 10 – 12 ( The difference between 10 and 12 is the spread )
Here, Let’s say the price of Eur/Usd is 1.3550 and am expecting Eur/Usd to rise to 1.3700, so what I need to do is to buy a CALL option at 12 strike price. And once the Eur/Usd price reaches 1.3700 the strike price value will be increased to some 30. And here you need to understand that it can happen in either way as well if the Eur/Usd price drops to 1.3250, the strike price then will reach some value at 5 strike price.
Now, Let’s do the math
- Asset Bought : Eur/Usd
- Option : Call
- Strike Price : 12
- Size : 1 Lot or 1 Contract
- Price per lot/contract : $10
- Amount to be invested : $10 * 12 = $120 ( Price per lot * Strike Price )
- Expiry Date : May 30th,2013.
Note :- We are buying an OPTION or CONTRACT, so we need to specify how many contracts are we buying which is called the size of the contract.
We invested $100 to buy one single contract of Eur/Usd CALL OPTION at strike price 12. Now later, when Eur/Usd rises to 1.3700 the strike price has risen to 30.
Doing the math again, the strike price has risen to 30 from 12. Where even my contract value has increased from $120 ( $10 * 12 ) to $300 ( $10 * 30 ).
Now the profit made is $180, deducting initial investment from the contract size at 30 strike price.
Let’s assume the Eur/Usd price going down to 1.3250, where the strike price goes as low as in 5.
Now, the contract value has dropped to $50 ( $10 * 5 ), where initially we invested $120 when the strike price was 12. So here, we have lost $70 ( $120 – $50 ) .