Classic options are financial market products whose history goes back a long way. The purpose of these products was originally to secure or set a price for a business in the future. So if a farmer expects that the harvest will go very well this year, that is, the prices will decrease overall, then he can hedge against it through option contracts. This means that option contracts are a kind of insurance for the commodity trader. Futures also belong to the class of hedging instruments.
The difference is that futures are contingent transactions. The underlying contract in the future deals with mandatory services of both parties. However, options give the buyer the choice. So if our raw materials trader misjudged the harvest and the prices do not fall below the agreed price, then he does not have to fulfill it. He can then sell his crop at market prices.
Over time, however, options have also established themselves as speculative instruments, albeit with a certain strategy of hedging. Market indicators are also calculated on the basis of options, which represent a general situation regarding the current risk appetite of market participants. For example, the Volatility Index (VIX).
Since options are still used as hedging instruments, the VIX gives a look at whether there are currently many hedging activities in the US index S&P 500. If the VIX rises, it means that hedging activities will also increase and market participants expect a falling S&P 500 index. This is also a good indicator to develop trading strategies as it is both technical and involves sentiment (majority of traders).
The VIX is sideways in the long run. Nevertheless, the chart clearly shows that the VIX, which has been falling since mid-October, coincides with the rising stock markets.
Difference between investing and speculating
Binary options, on the other hand, are initially speculative products. This is because they are usually traded at short notice. Nevertheless, in some cases binary options can also be used as hedging instruments.
But the investor or prospective trader mostly wonders whether he can also invest money with binary options. You should know the difference between investing and speculating. So what is investing?
Investing means assigning a project a certain value that can be expected to increase in the future. The investor, such as Warren Buffet, assumes that a stock is cheap at the moment and has potential for appreciation in the next few years. But he comes to the conclusion when he realizes the true value of the company. The basis of an investment is therefore:
The time is in most cases for an investment longer than in speculation. And that's exactly why binary options are falling out. There are only a few brokers who offer options with a term of more than one year.
Why is valuation so important when investing? You can put it in a simple answer.
"The longer the investment period, the greater the likelihood that the valuation will work."
In the case of speculation evaluation is important, but the value in the far future does not have to coincide with the current development. Speculation focuses on short-term events, and short-term means up to a maximum of half a year.
Based on the initial example of options, this would mean that, unlike the investor, the speculator takes advantage of the price decline in raw materials wants if he assumes that it will decline due to a good harvest.
So it is not the value that is important for speculation, but: How does the value behave in the short term due to an event?
The investor assumes that commodity stocks are cheap at the moment, since commodities have also fallen recently. However, he expects an increase in raw materials in the next two years and thus an increase in the value of raw material producers. He buys shares of the company and leaves them in the custody account for two years.
Admittedly, the example is somewhat simplified but representative.
The It is speculated that Deutsche Bank will publish good quarterly figures next time because it has either followed the development of the entire industry or because it has other positive information. He continues to believe that the publication of the positive numbers will initiate a boost in the share price. He wants to use that.
He can then implement it by trading binary options, since on the one hand only a small amount of capital is required and on the other hand no transaction costs are incurred. The speculator could therefore buy a binary option from the broker OptionBit on the Deutsche Bank share. If he is right, he will get a return of 78%. If he is wrong, he loses his stake, but nothing more.
The difference and advantage compared to speculation with the actual share lies on the one hand in the low use of capital and that there are no costs for the transactions. In addition to the analysis, it is only the increased risk of losing that the speculator must also manage. It does not matter to him how the value of the share will develop in the next few years, although one has to say that a well-founded analysis would not be a disadvantage even in the case of speculation.
Read ours too sBroker test report.