Trade shorter term, all the way down to a 5-minute time frame and do it with style!
You know a bit about options. Some call them Traditional Options and others call them Vanilla Options. Whatever you call them, they are all the same. They are priced the same. They move the same.
There is a type of option that is vastly different, and more awesome if you ask me. We will dive into the newest type of trading derivative called ‘Binary Options’ or Digital Options.
Binary Options are Simple to Understand.
Can you count to 100? Go ahead and count. I will wait…………. Ok if you can do it, then you can trade binary options with ease. These little bastards are meant to make trading options a whole lot easier:
- Easier to understand
- Easier to trade
- Easier to manage risk
- Easier to calculate
Everything you need to know about binary options in 27 minutes
A little history lesson to get us started.
Before moving on with binary options, you must know a few things about them. Let’s rewind about a few years, to 1996, and take a look at when forex became available to trade on the internet. Nirvana was big and so was dial up internet. Forex brokerages were popping up all over the place and there was very little oversight.
Forex traders were getting ripped off by unregulated brokers, posing as the real deal. Spreads were HUGE (100 pips on the EURUSD for some brokers). Traders were lured to this exciting game because it was more straight forward than stocks and you could trade with almost no cash. Brokers would offer 1000:1 leverage (the ability to control $1,000 with only $1). Brokers would give bonuses, just to get your money and then shaft you. It was the wild west. Eventually, regulation and oversight fixed most of this and today, forex trading is a normal course of business in trading.
Brokers would offer 1000:1 leverage (the ability to control $1,000 with only $1). Brokers would give bonuses, just to get your money and then shaft you. It was the wild west. Eventually, regulation and oversight fixed most of this and today, forex trading is a normal course of business in trading.
Scam Brokers
The same thing is happening with Binary Options right now. Since they are a new way to trade, there are many unscrupulous brokers, out there, who are shafting traders and making it damn near impossible to make a withdraw of their funds.
These fake brokers only make you think you are trading but your orders are never executed on an exchange of any kind. We will talk about scam brokers a little later; but for now, just be aware that they are out there and you are going to want to avoid them at all cost.
Real Binary Options Exchanges
The ONLY binary options you want to trade are traded through regulated arenas such as:
IG.Com For those who live outside of the U.S.A.
Take a few minutes and click on one of these sites. Familiarize yourself with them. Make sure you are trading with a reputable firm before depositing your money.
Binary Options Nitty Gritty
Since you already know about options (If you didn’t skip ahead), now you will learn about binary options. Let’s review a few terms and how they work with binary options.
- OTM – Out of the money
- ITM – In the Money
- ATM – At the money
- STRIKE PRICE – The price of each trading level
- EXPIRY – The time that each contract ends
- CONTRACT – An agreement between you and another trader or market maker
Do you know what these terms mean? If yes, then proceed and if not, then rewind to our previous module on OPTIONS.
Zero to 100!
Binary options are fully collateralized contracts. This means you can not lose anything more than what you put up for your contract. In other words, they have capped risk. Let’s talk about contracts and pricing.
CONTRACTS BETWEEN YOU AND ANOTHER TRADER OR MARKET MAKER
A contract is an agreement between two traders with an opposite view of the market. An exchange will match up a trader who wants to buy and a trader who wants to sell at the same time. When the two are matched, a trade is placed.
Every Binary Options contract settles at 1. For one exchange, this equals $1 per contract. For another, this is $100 per contract.
If you are correct or (ITM) in-the-money upon expiry, your contract is worth 1. If you are not correct or (OTM) out-of-the-money upon expiry, your contract is worth $0. So upon expiry, if you do not choose to close your trade early, your contract is worth either 1 or zero and this is why they are called binary options. They can not be worth 2 or 6 or 1.10. It is ALWAYS one or zero. (Some exchanges have a push at 50 when price settles EXACTLY at the strike.)
BINARY OPTIONS PRICING
The price of each contract is usually quoted by a market maker, by using the delta of the the Black and Scholes model for options pricing. This is just for your reference but an easy way to view pricing is that what you see is the probability, AT THAT EXACT MONET IN TIME, that the trade will expire profitably.
Basically, when you buy or sell a binary with Nadex, the price you see if the price at which you are buying or selling. If you see the following:
…then take a look at the AUDJPY 0.8675 strike. Do you see the two prices there:
BID 5.75
OFFER 12.25
This means that you can buy the offer at 12.25. This 12.25 is your risk because a binary is from 0-100. If your risk is 12.25, then just subtract it from 100 to get your potential profit. 100-12.25=87.75. This means that $87.75 is your potential profit. Anytime you are buying, this is the formula you use.
Take a look at the bid now. You can sell the bid at 5.75. If you are selling for 5.75 and the binary only goes from 0-100, then what is your risk? 94.25 is your risk. You are selling at a price of 5.75 and the ‘ceiling’ of this trade is 100; it can go no higher. What is your potential profit? That would be $5.75 or the bid price.
You can look at it this way, If you want to buy a car and the car can be valued at no more than $100 and you buy this car for $66, then your risk is $66 and your potential profit, if the value of the car goes up, is $34. If you own the car and want to sell it at a price point of $60, then you will make $60 or lose $40, because the price of the car value can go no higher than 100.
It’s as simple as that. Now lets review popular options and binary options terms.
ITM
ITM is an acronym that means “In the money”. If you are trying to buy an asset at a lower rate than where price is at this current moment in time, it is called an ‘in the money’ trade’ or ITM. This is because if price were to expire right now, at this very instant, you would win your trade.
ITM can also be used for closed trades. Binary options traders will say, “That trade closed ITM.” This means that their trade won. It closed in the money.
ITM trades will always cost more for you to trade. This is because price does not even have to move for you to make a profit. If price just sits there until the end of the contract, you will profit. You are paying more for the risk the other trader (the one you are trading against) is taking. He is taking more risk on the trade so you pay for that risk.
Check the following picture and imagine you are BUYING the offer.
ATM
ATM stands for “At the money” and means that a price of any binary option is right there at the level (or darn close to it) you want to buy it at. If the price of the AUDJPY is 85.75, then a true ATM price will be identical at 85.75. In the following example, we show a strike price of 85.75 and an underlying price of 85.53. Since the underlying price is UNDER the strike, even by a few pips, it is technically an ITM trade (if buying) but it can also be referred to as ATM because it is so darn close.
Every time you buy at ATM contract, you will pay about 50 for it (in an ideal market but in this scenario, you will pay 45.00). You are paying 50 and the counter party is paying 50 as well because both of you have exactly the same probability of a win or loss. Both parties are taking the same risk.
OTM
OTM is the last of the 3 main terms. It stands for “Out of the money” and means that our binary option is worthless if it were to end this particular contract right now. It will expire out of the money.
We pay less for an OTM trade simply because the price has to move a certain distance before we can make a profit. The other trader (the one we are trading against) pays more for his side of the contract because his side is already in the money. An OTM trade is technically riskier because the price has to move before you can make any money, however, you are not risking as much.
Strike
A strike, or strike price, is just an area that you can buy or sell and that’s all it is. Don’t look too deep into the meaning of this term. There are many different strike areas. Depending on these strike areas, you can buy or sell itm, otm, and atm contracts at various prices.
On the chart below you will see various strike prices and levels. Currently, I can buy a contract for 45 if I chose the 85.75 strike. Why is this? It is because the price at the current time is ATM or ‘at the money’ so the contract will cost around 50 (45 in this scenario).
Expiry
The term ‘expiration’ is about the easiest to explain. The expiration is the time that the contract ends. Here is how it works in a nutshell. Trader “A” scans the charts and finds that he wants to trade a contract only for the 20 minutes. He then chooses a contract that ends in about 20 minutes. He places his trade and in 20 minutes the trade will be over. Upon ‘expiration’ or expiry, one trader will walk away profitable and the other trader will lose his investment.
There is no other outcome. You can not extend a contract. Once the deadline comes, you are out, no matter what.
Put it All Together
Now let’s put all of this together because when you take all aspects and put them together, it creates a contract. The contract needs the following items to become a contract between 2 traders:
a. A trader willing to sell and a trader willing to buy
b. An agreed upon price for each
d. An agreed upon strike price
e. An agreed upon expiry
If you have all of these items in place, you now have a contract between 2 traders and once the traders enter into this contract, they will know the outcome once the contract has ended.