Especially when an inexperienced trader or novice trader stumbles across the term "binary options", he will in most cases ask himself what is the real difference to normal financial options. Often he won't get the answer to this question. Options are too extensive and too complicated for many private individuals. Options are not easy to understand, especially if this group of people has so far only had contact with the stock market.
This article is intended to illustrate the properties of an option and its differences from binary options in a simple and understandable manner. First describe how the basic properties of an option:
- An option is a derivative. That the option is always linked to the development of a financial market product such as shares, raw materials or currencies.
- An option is a kind of insurance. Not infrequently also a speculation tool. Because an option gives the holder the right, but not the obligation (unlike futures) to exercise a certain contract in the future or not. This gives you a limited risk of loss on the one hand, but an immensely large chance of winning on the other.
- Options are available for rising and falling prices (call / put)
- Options can be - and sold
The following example is intended to illustrate the properties again. An investor in this case we take the founder of Facebook, Mark Zuckerberg, bought several million call options when his shares went public. The future price of the Facebook share is therefore the underlying on which the option as a derivative depends (see 1.).
Zuckerberg or his advisors have assumed that the share will rise within a few years. Although it initially devalued massively, it stabilized in the following years and rose. However, Zuckerberg's call options gave him the right to buy shares at the price at which they were valued when the options were purchased, i.e. at a much lower price. It is clear that he would exercise this right if the current price was higher, otherwise he would let it expire and lose the option costs.
Zuckerberg exercised the call options and previously sold his shares already in the portfolio with a profit. A classic case of speculative gain (see property 2), because hedging (see also property 2) would have to take place in the opposite direction and against falling prices (put). Here the consultants must have been pretty sure that the price of the Facebook share would go up.
But let's assume that Zuckerberg wants to hedge against falling prices. Then he would have to buy put options that give him the right to sell his shares at a higher price, namely the price when the put options were bought. If the price is actually lower, he sells the shares at the higher price and buys them back at the current, lower price, thereby posting a profit. This profit then makes up for the losses he suffered from the falling share price. The so-called hedging.
Differences to binary options
What are the differences to binary options? The mere fact that it is a "binary option" means that there are only two options for trading this instrument. "Either or" is also often used as a synonym. So you either choose one direction or the other. Binary options can therefore not be sold or not yet sold but only bought.
However, this option is available for the regular options. If Zuckerberg wishes to sell options, he undertakes to hold a proportion of the shares until the option expires, until the option buyer has decided after the time whether he wants to exercise the option or let it expire.
That one binary option is a derivative, that's very clear. But what about insurance? Since hedging in most cases requires a longer investment horizon, binary options are less suitable for hedging.
And what about the payment structure? The payout structure of the binary option is very similar to the regular one. With both, you only pay the purchase costs and in the worst case just lose them. The difference is in the details. While normal options are traded on the stock exchange, their pricing is different. Both the price of binary options and the payout are determined by the broker itself. Binary options are so-called OTC derivatives and are offered by market makers.
In many cases, the use or costs of binary options is almost as high as the payment. This in turn depends on the type of option we want to trade. Is it a simple higher / lower option or maybe a boundary option (price stays within a range).
In the first case we see a simple rise / fall option at Broker Binary.com. Here the cost of a rise option is $ 53.20. The payment if the course is positive is 100U $. That would be 88% profit on the stake. If the loss is negative, you lose 100% of the stake.
In the second case, we see an in / out option from the broker Binary.com. This option is very cheap in relation to the payout. If the price is within the respective range after one day, a profit of 1026% is possible.
In conclusion, it can be seen that binary options have the same basic properties as normal options. Ultimately, the design of the price and the usability are limited on the one hand, but on the other hand very well equipped for speculative, short-term trading.