As you probably already know, all binary options involve the prediction of the monetary value of a certain underlying asset at some point in the future as compared to the present moment(the point is called “expiration date” or “expiration time”). Your investment is based upon your initial prognosis.
In the scenario where you conceive of a high probability of the price of the asset being higher than than it is at the present moment, then you buy a call option.
If, however, you speculate that the asset’s value will drop and will be lower in a specified moment in the future, then you buy a put option. In reality, this notion represents a huge chunk of what you actually need to know about binary options, but since there are other variations, we will take a more detailed look and introduce you to the more common binary options types you might encounter if you decide to trade.
Up/Down or High/Low
Different brokers may use different terminology for this type of binary options, but you need to factor that out of the equation: whatever terminology they use, this is by far the most common type of binary option. Most of the scenarios we’ve talked about so far have been in the realm of Up/Down options. Here, however, we will introduce you to more details regarding this particular variation.
The principle guiding this sort of binary option trading is rather clear – what change will occur in the underlying asset’s price from the moment of investment to the expiration date? The price of the asset at the moment you are buying the binary option is called a “spot price”. If you contemplate that the price is going to be higher at a certain point in the future (or the expiration date), then you purchase a call option and win if the prerequisite conditions are met (the price at the expiration time is indeed higher than the spot price).
The alternative is buying a put option. The inherent nature of the put option requires the price of the underlying asset to be lower than the spot price at the expiration date for you to profit. You need to think carefully, follow trends and create a feasible in order to conquer the probabilities, make a profit and cut your losses.
Higher/Lower or Above/Below
This variation of binary option bears almost disorienting similarities to the Up/Down option, and indeed many people who lack experience and expertise in the field of binary options get them confused. The bewildering component is this – unlike Up/Down, Higher/Lower (or Above/Below, which is how it might be presented with some brokers), the main reference is not the spot price (the current price of the asset), but a value you choose. You, as an investor, are the one who commands barrier or target price. The spot price is irrelevant in this sort of options trading. You put up a barrier and decide if the asset’s price will be higher or lower at the expiration date. Just like with Up/Down, if you believe that the price will be higher than the barrier, then you you buy a call, and if you consider it will be lower – you purchase a put.
There are obvious parallels between Touch/No touch and Higher/Lower. Once more you begin by selecting a barrier. This time, however, fluctuations of the price of the asset during the given time frame (from the option purchase to the expiration time) are very important because they will decide whether you win or lose. If you select “Touch” and the price becomes equal to or passes the barrier (in other words “touches” the barrier, which is where the name of the option originates from), then you can collect your profit. If it doesn’t, then you lose. The same principle is applied to No touch, but in reverse, meaning that if you buy a No touch option and the price never “touches” the barrier, then you may collect your profits.
This is where things get a bit more complicated (although not really since we’ve already introduced you to the most basic concepts). In/Out options resemble Touch/No touch, but they introduce a second barrier. You have to choose two barriers instead of one and these two barriers will serve as boundaries. If you decide to go with the “In” option, then you wager that the asset’s price will stay persistently within the set perimeters during the entire time frame. If, for one reason or another, the price fluctuates enough as to leave the boundaries, then you lose your investment. However, if you decide to purchase the “Out” option, then the situation will be reversed – you will once more set the boundaries, but this time what you wager (and what you look out for trembling in anticipation) is that the price will not stay within the boundaries and will instead fluctuate enough as to leave them. In case you turn out to be correct, you will collect your profit, and if not, you will lose your entire investment.
Very Short Term Trades
The common denominator between all sorts of short term trades (be it 60 seconds, 2 minutes, 5 minutes, etc.) is their minute duration and tiny expiration times. The most common variety of these binary options is the Up/Down trade. The explanation is as short as the durations themselves.
Binary options present you with an appetizing potential return based on your monetary investments. Various brokers utilize different methods, systems and instruments in order to calculate the exact financial return and since the process is immensely complicated, the information isn’t disclosed, although they can always demonstrate what you can expect in regards to profits before you begin investing your money.
There is a wide plethora of factors that can significantly influence the outcome of a trade, as well as the potential return. An excellent example would be the type of option you choose. Up/Down bets pay less than Higher/Lower options due to the higher risk involved in the latter.
Duration of Trade
The duration of the trade is yet another important factor which significantly influences the payout. At the first glance it would seem that a longer duration should pay out more than a shorter one, the logic behind this reasoning being that long term trends are harder to predict than short term occurrences. Indeed, it seems that it’s much easier to predict what will happen in the next 60 seconds or 10 minutes, than it is to spot a tendency for the next few days, weeks or even months.
However, upon a closer inspection we see that, in fact, the short term market has bigger fluctuations and even though they may be temporary, they might cause you to lose your investments. The truth is that it’s impossible to predict what exactly is going to happen in the next 60 seconds. Any forecast you make will be arbitrary at best and if you win it will be mostly because of luck, rather than careful planning, studying the financial history of the asset and doing extensive research on the matter at hand. If you’re interested in this high-risk game (note that this type of options trading is closer to gambling than it is to rational investment), then you can look around – there are lots of brokers who offer more than generous payouts, frequently more than 70%.
The nature of the underlying asset is yet another aspect of determining your potential return. The general tendency is that currency pairs pay more than stocks, for example. This is something you can easily learn before you make an actual investment because, as we’ve already established, in binary option, the potential return is known in advance. Keep in mind that all other things being equal, different brokers may offer varying returns, some being stingier than others.
The final unknown of the equation is asset volatility. “Volatility” is just a fancy way of saying “price fluctuations within a period of time”. Higher volatility means bigger fluctuations. There are known cases of brokers removing certain assets from a trade due to a high volatility. Naturally, higher volatility means that it’s more difficult to predict where the asset’s price will sit in a certain point in time.