Binary Options Trading Tutorial
1. How To Trade Binary Options
2. Learning More About Binary Options Trading
3. Forex Compared To Binary Options Trading
4. What Assets To Trade In Binary Options
5. Why Trade Commodities?
6. Binary Option Trading Strategies
Introduction To Binary Options
Binary options is one of the latest innovations in the financial markets. They are also known as “Digital Options” as they have only 2 possible outcomes. Investors in binary options will reap a predetermined amount of profit if they expire “in the money”. Conversely, if a binary option expires “out of the money”, they will only suffer a fixed amount of losses. For example, if a binary options pays out 80% and expiry falls in the money, this mean for an investment of $100, the investor will reap a return of $180 (a profit of $80). On the other hand, for the same amount of investment ($100), if the option expires out of the money, the investor will only stand to lose $100. Nevertheless, binary options brokers often offer up to a 15% refund on the amount invested if a binary option expires out of the money.
Binary options is an OTC market meaning over the counter, this means that a the broker offers directly the assets to the trader without a third-party such as a bank. As binary options is global there is always a market to trade, across the Stock Exchanges of London, NY and Asia. It’s a veritable 24/7 market which is one of the reasons it holds such appeal. With the advancement of online trading during the last few years, Binary options are available to be traded on any web trading platform provided by the binary options brokers. These web based platforms have all the necessary tools like prices and charts displayed in real time to help traders get a sense of the market. Once the trader has decided on his investment strategy, the purchase of a “Call” or “Put” binary option can simply be done with just a click of the mouse. Furthermore as the trading platform is web-based, binary options traders can trade from any location around the world.
Compared to Vanilla options (normal options), binary options have a different risk/reward structures and different fees as well. Nevertheless, because they have just two possible outcomes, binary options are extremely simple and novice traders can easily get a grip on them and use them for investment purposes. The trader is only required to bet on the direction of the price fluctuations and the quantum of the fluctuations to win the wager.
For example, if the trader feels that the price of an asset will rise, he should put his money into a “Binary Call Option”. Alternatively, if the trader feels that the price of an asset is going to fall, he should then buy a “Binary Put Option”. The correct determination in some cases can yield returns as high as 85%. But what is really attractive about binary options is the fact that they help investors to quantify their risks. Binary options cover a wide range of markets. There are binary options to allow traders to trade with bonds, Commodities, Bonds, Forex and indices. Some brokerages even offer binary options for traders to make money off economic news like interest rate decisions by the Federal Reserve or the European Central Bank (ECB).
Binary options being a Fixed Rate Option (FRO) have a predetermined fixed percentage of return unlike vanilla options. The potential gains of Vanilla options can be infinite but theoretically, their risk levels are much higher as well.
Comparison between Binary Options and Vanilla Options
1. Expiration Time:
Binary options are available with a variety of expiration time like 5 minutes, 15 minutes, hourly, daily, weekly and monthly. Vanilla options on the other hand expire once a month.
The payouts for binary options are fixed while vanilla options’ returns are based on the dynamics of the market.
3. Expiration in the Money:
Expiration in the money for Vanilla options are based on a relationship between the strike price and the underlying price of the asset. For binary options, traders only have to be concerned with the direction of the price movement.
4. Right To Buy:
With Vanilla options, the holder of the options has the legal rights to exercise the options into stocks. For binary options, no such rights exist.
Due to their simplicity and the fact that they are issued 24/7, the potential gains to be realized can be quite significant for the average retail trader without having to resort to complex technical analysis.
As an Over-The-Counter (OTC) market, binary options are traded globally and across different time zones allowing for 24/7 trading. The scope of the types of assets for binary options covers different markets like:
This market covers all the major currencies traded and some minor currencies as well (depending on the broker). These include:
Binary Options for Commodities are based on the futures contracts that are traded on the CME Group. They include:
• Crude Oil
• Natural Gas
Stocks & Indices:
Binary options for stocks of major Multinational Corporations are also available to be traded now. A trader during the trading for Asia can trade in binary options for stocks and indices like:
• ASX 200 Index
• BHP Billiton
• Commonwealth Bank
• Hang Seng Index
• Macquarie Group
• Newcrest Mining
• Nikkei 225 Index
• Rio Tinto
• Straits Times Index
• Tata Motors (India)
• Toshiba Co
During the trading day for Europe, traders can deal with binary options for stocks & indices like:
• BNP Paribas
• CAC 40 index
• FTSE 100 index
For the U.S. financial market, traders can invest in binary options for stocks and indices like:
• General Electric
• Microsoft (US)
• NASDAQ indices
• Nike (US)
• Reuters (US
• S&P 500
Apart from the wide range of assets to trade in, traders for binary options also have options to trade with different types of binary options like:
• Cash or Nothing
The classic version of the binary options platforms where traders have to speculate whether the price will rise or fall.
• Asset or Nothing
Essentially the same as Cash or Nothing options with the difference being having the option price fixed by the asset price instead of being random.
• One Touch
The trader has to determine the exact value that he thinks the asset price will reach upon expiry of the binary option.
• No Touch
“No Touch” binary options are the exact opposite of “One Touch” binary options. Instead of hoping for the value of the option to coincide with the asset price upon expiry, traders in this case try to determine the threshold that the asset price will never reach upon expiration.
Binary options are especially useful for those investors who are interested in trading in the Forex market. The Forex market is currently the largest financial market in the world with a daily turnover of at least three trillion dollars. As the most liquid market in the world, this provides plenty of opportunities for traders to make money from the volatility of this market. As binary options are simple and less risky, retail traders are emboldened to take more chances to invest in this lucrative market.
Spot Forex trading, by definition, is the buying and selling of currencies of different countries. For those who are new to the financial market, when we talk about Forex trading, we are always talking about dealing with a “Pair” of currencies. In other words, it is about buying a currency and selling another currency simultaneously. For example, when we buy the EUR/USD currency pair, we are buying Euros and selling U.S dollars at the same time. Conversely, when we sell EUR/USD, we are selling Euros and buying U.S dollars simultaneously. The exchange rate of these two correlating currencies is determined by the market.
The way which Forex traders earn is by pocketing the differences between the prices they paid for a currency pair to that of the prices which they get when they liquidate their market position. In short, there are two ways to go about trading Forex. The first way is by dealing directly with the currency pairs themselves. If a Forex trader feels that the U.S dollar is going to rise against the Euro, in this scenario to profit for the upward fluctuation of the U.S dollar, the Forex trader will need to hold a “long” market position on the EUR/USD currency pair.
In other words, the Forex trader needs to sell Euros and buy U.S dollars and hold this position until the U.S. dollar exchange rate rises in relation to the Euro. Once the trader feels that the rise has plateaued, he can then liquidate his market position to realize his gains. When trading in Forex, a trader will be required to hold or sell his asset until:
1. He liquidates his market position manually to realize his profit or minimize his loss.
2. His trade is closed automatically due to a “Stop Loss” or “Take Profit” order.
3. His trade is closed due to a “Margin Call”. A margin call occurs when the balance in the trader’s account falls below the broker’s required minimum deposit.
Forex traders utilize the margin facility provided by their brokers to leverage their investment capital a few hundred folds in order to maximize their profit potential. Nevertheless, the risk pertaining to a Forex trader’s transaction is also magnified many folds to the extent that a trader can lose his entire trading capital in his trading account if the market moves against him. This is the main reason why Forex trading in itself is extremely risky.
The second way to trade Forex is with binary options. With binary options trading, the risk is lowered significantly to the extent of a trader’s investment and not to the extent of his entire trading account capital. It is just like purchasing any options as the trader can only lose the actual amount invested. Besides having lower risk, a trader can have more control over the level of risk he wants to undertake. Furthermore, even if the binary option expires “out of the money”, the trader can still recoup a portion of his initial capital investment (normally around 10% to 15% depending on the broker).
In addition, with binary options trading, traders have more asset types at their disposal, to take advantage of the various market situations. For example, let’s say the market is ranging, with normal Forex trading; a trader is likely to incur losses due to his stop loss orders catching. With binary options trading, a trader can use “Range Binary Option” to profit from the market when the market is within a range as well as outside a range.
Another type of asset which is available with binary options trading but not normal Forex trading is “Touch Binary Options”. With this type of binary options, traders can profit from situations where the market is “testing” the support and resistance lines but doesn’t breach them. With normal Forex trading, a trader can only trade in one direction and when the market is volatile with strong fluctuations; such situations tend to result in Forex traders suffering losses. This is another area where binary options trading reign supreme.
In summary, although the level of possible profits achieved is higher with normal Forex trading, the risk level is also very much higher as well. With binary options trading, the risk level is lowered significant while still allowing traders to reap a respectable amount of profits. In short, binary options trading is ideal for those traders who are just getting their feet wet in the financial market.
While binary options are simple as compared to vanilla options, the calculations behind the pricing of them are complex and sophisticated. It is for this reason that binary options are classified under the umbrella of exotic options. Hence the type of assets to trade in with regards to Binary Options trading depend very much on which financial markets that the trader want to focus on.
Binary options are generally available for the four (4) financial markets listed below:
Each of the above mentioned markets have different characteristics and different factors that will influence them. Although binary options are simpler and less risky than the traditional financial instruments, one must still be aware of the fundamental factors that can cause prices to fluctuate. In other words, traders must be aware of both macro and micro factors that affect the respective markets. Making profits with binary options trading is dependent upon traders selecting the right category of asset to trade in.
The Commodities Market:
The Commodities market deals with raw and unprocessed products from the mining, oil and agriculture industries. In this market, you get products like Crude oil, natural gas, gold, silver, copper together with many other organic products cotton, coffee, cocoa and concentrated orange juice. What is special about the Commodities market is that they are moved more by expectation of the future. The prices reflected in the commodities contracts actually represent what the market is willing to pay for them sometime in the future. Futures contracts are usually for a three month duration. Therefore, to get the most out of this market, traders for binary options in commodities should trade at the beginning or towards the middle period of the three months futures contracts.
The Forex Market:
Forex trading can best be understood as trading with currency pairs like the British Pound against the U.S. dollar. In other words, we are pitting the performance of the British pound to that of the U.S. dollar. The Forex market is unregulated and there is a great deal of volatility in this particular market. Because of the volatility, the potential for profit is high from the release of major economic news from the Federal Reserve and ECB. Hence, traders of binary options in the Forex should take note of events in their economic calendar.
The Index Market:
The index market is quite similar to the Forex market in the sense that trading is generally done electronically and available 24 hours a day. The index market is quite liquid as it bundles several types of assets together to be traded as one. In this respect, it is easier to trade than having to deal with individual stocks and commodities. However because of this bundling, the index market is not as price sensitive as individual assets. Some indices have a lag before they respond to the market trends. Traders who lack patience will definitely face a pitfall when it comes to trading in this market.
Although the index market is used to represent the longer trends, they can easily make a turnaround as result from the impact of an immediate knock-on effect of an economic situation. As the value of indices depends on a selected number of stocks, binary options trading is best done when major announcements are made by companies that are covered under the index. A good understanding of each index is essential as they all react differently to the market trends and market news.
The Stock Market:
Stocks from popular multinational companies are covered by the Binary options market. Even though the performances of stocks are affected by macro economic factors, they are affected to a greater degree by news of their respective industry as well as their profit and loss accounts. As such, the best time to deal in binary options for the stock market is when these companies announce their quarterly, half yearly or annual earnings.
Compared to the traditional financial instruments, binary options offer a distinct advantage over them due to the ability to quantify the risk level for investors. The potential to reap high returns is still there but the losses are restricted only to the actual amount invested. With traditional financial instruments, because many traders leverage their investment capital with the margin facilities provided by their brokers, these traders face a situation where their entire capital in their trading accounts can be wiped out in the blink of an eye if the market turns against them.
The likelihood of total loss is very high especially for volatile markets like the Commodities market and Forex markets. As such, many traders are using binary options to trade in the Commodities markets as well as the Forex markets. As we have covered trading in the Forex market with binary options in the above sections. This section will discuss about trading in the Commodities markets with binary options.
The commodities market is made up of several parties like the producers, middlemen (whole sellers), dealers and traders. All the combined activities of the various stakeholders result in a huge turnover in the commodities market with each party trying to pass the risk of uncertainty to each other. This is how profits are made by the party that made the right determination and losses incurred by those who bet on the wrong side of the market.
The commodities market is about future expectations. Producers of agricultural products use this market to hedge the risk of lower prices for their produces with the futures contracts. Unpredictable factors like adverse weather can easily wipe out an entire season of crop within a few hours and this is why sellers and producers trade in the expectations of the future to lower this unknown risk factor.
For traders, to hedge the risk level against the volatility of the commodities market is more risky than using binary options. We already explained earlier why using vanilla options can easily wipe out a trader’s investment capital in a blink of an eye if the market moves against him. Because binary options allows trader to quantify the risk factor, they can be said to be a better investment vehicle for this particular volatile market.
Depending on the actual market situation, binary options traders only have to predict the trend of the market and ignore the pricing level to be achieved. If a trader predicts that the market is on an upward trend, he just needs to buy a binary “Call” option. For a downward trend, the trader just needs a binary “Put” option to secure his position.
It should be noted that futures contracts expire on a monthly basis but with binary options, traders have the opportunity to buy a binary option with a time period as short as 5 minutes slot and 15 minutes slots. In this sense, Binary Options are the perfect alternatives to traditional financial instruments for volatile markets like the commodities and Forex markets.
Although relatively simpler than Vanilla options, to profit from using binary options from an uncertain financial market, a trader will still need to undertake a binary option trading strategy to help him make the correct market determination. In this chapter, we will cover some of the basic strategies which binary options which binary options traders can employ to help them with their investment decisions.
Minimizing Losses and Maximizing Gains
One successful binary options trading strategy used by traders involve the use of both a “Call” and “Put” option on a traded underlying asset. The aim is to maximize profits and minimize losses at the same time. Nevertheless, certain market conditions must be fulfilled before one can apply this strategy.
For example, let us assume that you purchase a one day call option for an underlying asset with a strike price of $50.00. Let us further assume that after a few hours the underlying asset price had increased to $51.50. This would mean that your investment is presently in the money. All things considered, such an increase is a good upward tick for just a few hours (a 3% jump). At this point of time, you might want to consider buying a put option to lock in your profits. This maneuver is to protect you in the event the underlying asset price will drop or level off at this point.
You have to invest in the same amount of put option as you did for your call options. By doing so, you double your profits if the underlying asset price continue to rise. And if the price drops below $51.50, you would have minimized your loss as your put option expires in the money to offset the amount that you lost on the call option. The same strategy is also applicable for a downward trend market.
Tools or Indicators for Binary Option Trading Strategy:
• Support And Resistance Lines
Support and resistance lines are one of the most helpful tools for binary options traders for discerning whether the market is on a downward trend or upward trend.
• Technical indicators in binary options trading
Technical indicators are useful in helping to predict the fluctuations in the market for the short term period as they are widely adopted by traders all over the world. They actually help to create the momentum in the market because everybody is the market are buying into the market based on these technical indicators. Some of the popular technical indicators used by traders include:
o Bollinger Bands
o Moving Average Convergence / Divergence (MACD)
o Stochastic Analysis
Actually the number of binary options trading strategies that can be adopted by a trader can be substantial. The key toward successful trading is to adopt what is right for your style as we are all individuals with different personalities. As with Forex trading, there must be discipline and a consistent approach towards trading in the volatile financial markets to come out ahead of the game.
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Disclaimer: The opinions expressed in this article are not necessarily those of OptionsClick, blog.optionsclick.com, OptionsClick.com or any of its staff. The contents of this article are in no way intended to be advice or any other form of counsel for any trader of binary options or any other investor. Please be advised: Investing of any kind always carries a relative risk. As with any market trading, it is always possible to lose your investment. Always be sure to do your own research, seek professional advice, and make your own, well-educated decisions when it comes to financial investments.