Binary Option Basics if Trading Outside the U.S.
Binary options traded outside the U.S. are different than binaries traded in the U.S. If you are a U.S. resident or want to trade binary options in the U.S., see Binary Option Basics in the U.S. If you want to trade binary options outside the U.S., here's a basic rundown on how basic binary options work.
How Binary Options Work
Will the price of the EUR/USD be above 1.1125 at 1:10 PM today? If you think it will be you buy a Call option. If you think the price will be below that price at that time, you buy a Put option.
The price in question is called the strike price. If the EUR/USD is trading above 1.1125 at 1:10 PM then those traders who bought Calls will make money, and anyone who bought Puts will lose money. If the price is below 1.1125 at 1:10 PM then anyone who bought Puts will make money and the Call buyers will lose.
Every binary option has an expiry, and it is the price of the underlying asset at that expiry time that matters.
Think of the binary option as a side-bet on an asset's price. You are not buying the asset directly, in this case, the EUR/USD forex pair, rather you're placing a trade based on whether the asset's price will be above or below the strike price when that particular option you participated in expires.
Binary option brokers continually provide options to trade throughout the day, with expiries ranging from 1 minute away to months away. They also offer binary options with different strike prices on many different assets including stock indices, actively traded stocks, forex pairs, commodities, and news events.
If you buy a Call and the underlying asset's price is above the strike price at expiry, you win and receive a fixed payout such as 70% (payouts vary by broker and option) of the amount you wagered on the trade. If the price is below the strike price at expiry, you lose, and you lose the capital you wagered on the trade.
If you buy a Put and the price is below the strike price at expiry, you win and receive a fixed payout. If the price is above the strike price at expiry, you lose and forfeit the capital you wagered on the trade.
While binary options do vary from broker to broker--as it is a largely unregulated market--typically you can enter binary options trades up until expiry, but you can't get out of a trade you're in before expiry. Once you are in you hold the option until expiry, waiting to see if you make or lose money. Some brokers allow you to get out of a trade before expiry, but charge a fee or keep a portion of your wager to do so.
Each binary options broker is slightly different, so read all the fine print and try a demo account before placing any real money trades.
Binary Options - Maximum Profit and Loss
Binary options offer a fixed-risk fixed-reward trading opportunity. If you lose on the trade typically you lose the amount you wagered. For example, if you bet $100 that the EUR/USD is above 1.1125 at 1:10 PM (Call option), and the EUR/USD is at 1.1120 at 1:10 PM, you lose your $100.
If you are correct, though, you receive a fixed payout. Typically the payout is between 60% and 85%. In the example above, if the EUR/USD is trading at 1.1126 at 1:10 PM, you win, and will receive $60 to $85, depending on the exact payout for that option. Payouts are always listed next to any Put or Call option you buy.
Your profit or loss is directly tied to how much you wager on an option. The more you wager the more you can win or lose. All traders should keep their risk on each trade to a small percentage of account capital.
The attached screenshot shows USD/JPY binary option. Adjust the "Amount $" to change the amount you wish to bet.
Binary Options Fees and Capital Requirements
Typically there are no fees to open or close a binary options trade. The broker makes money on the spread between what they pay winners and what they take from losers on each trade.
Fees may apply if you request to close a binary trade before expiry. Broker specifications vary, but typically this fee will be a percentage of the amount wagered. The fee varies based on whether the option is in a winning position at the time of closure ("in the money") or if the option is in a losing position ("out of the money").
Binary option trading accounts can typically be opened for $100 or more. Note the minimum trade amount, though. Some brokers allow you to bet as little as $1 per trade, while others have a $10 or $20 minimum. Since you only want to risk a small percentage of your account on each, if you're opening a small account--$500 or less--look for brokers that allow you to bet in increments of $1.
Binary Options Pros and Cons
A 60% to 85% payout may seem like a great deal, but you are risking 100%. If a broker is taking 100% from the loser and only paying out 60% to 85% to the winner, they are taking the 15% to 40% difference for themselves. Your losses will always be bigger than your winners; this violates one of the cardinal rules for most traders--if you want to succeed, winners should be bigger than losers.
The binary options industry outside the U.S. is largely unregulated, with many brokers making up their own rules and not adhering to the financial standards required of reputable, regulated companies. The Securities and Exchange Commission (SEC) has issued on a number of occasions warning investors of potential pitfalls of trading binary options.
The positives are that it is a low barriers market to enter. Just because it is easy to set up an account and understand how the options work doesn't mean it is easy to make money, though. But risk is fixed, so if you bet $10 on a trade the most you can lose on that trade is $10. In traditional markets (stocks, forex, futures) you could receive slippage on an order, resulting in a larger loss than expected.
Final Word on Trading Binary Options
Binary options present a yes or no proposition. Will the price of an underlying asset be above or below a specific price at a specific time? Buy a Call or Put depending on what you believe. Your risk to limited to the amount you wager on that trade, and if you are correct you'll receive a fixed payout. Binary options are a low barrier market to enter but come with risks. Mainly, the industry is largely unregulated and prone to fraud. There is very little standardization, so one broker could vary drastically from another.
Read all the fine print if opening a binary options account, and research any broker you opt to deposit funds with.