In this article, I will attempt to demystify binary options terminology. The phrases associated with traditional options as well as binary options often seem foreign to traders and this is why many traders shy away from these awesome gems of awesomeness. What if i could show you how simple it is to understand binary options? Take a few minutes to read this article and your eyes may be opened a bit. If you find this article useful, feel free to share it! In fact, I want you to share it with about 15 other people because people need to understand the truth (you will understand what I am referring to near the end of this article).
#1 BINARY OPTION
When a trader buys a trading product of some sort, the eurusd for instance, he is investing his own capital into that product. If he buys the product, he is hoping the product will increase in value.
A binary option is just a contract between 2 traders who have opposing views of the market or are willing to take a calculated ‘bet’ by trading with another individual. If I choose to buy a eurusd binary option, I am entering into an agreement with another trader that I will put up an agreed upon amount of money that will settle at a period in the future. The other trader will do the same.
All binary options contracts equal 100. This is why they call it a binary. At expiration, the contract will be 0 or 100 for each trader. There are essentially only 2 outcomes.
The binary option will always equal 100, no matter if it is quoted in dollars or cents. If Nadex charges $100 per contract or Cantor Exchange charges $1.00 per contract, it is the same outcome either way; 100 (either $100 or $1.00)
ITM is an acronym that means “In the money”. If you are trying to buy the eurusd 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 trades 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.
ATM stands for “At the money”. This means that a price of any binary option is right there at the level you want to buy it at. If the price of the eurusd is 1.1320, then a true ATM price will be at 1.1320.
Every time you buy at ATM contract, you will pay about 50 for it (in an ideal market). 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 is the last of the 3 main terms. It stands for “Out of the money”. Out of the money 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 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.
A strike, or strike price, is just an area that you can buy or sell. 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 57 if I chose 1.1395 strike. Why is this? It is becasue price at the current time is ATM or ‘at the money’ so the contract will cost around 50.
I can also buy a contract at the strike price of 1.1385 for 73. This is because price is deeper in the money and has less of a probability of closing below my strike level. This is why I pay more for it; The strike is farther away from current price.
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.
A ‘call’ is the term in binary options that means a trader wants to buy. He wants the contract to go up.
A ‘put’ is the term in binary options that means a trader wants to sell. He wants the contract to go down.
Now let’s put all of this together. 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
b. A trader willing to buy
c. 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. Once the traders enter into this contract, they will know the outcome once the contract has ended.
The only ways to know the outcome are:
a. To wait till expiry
b. To close your trade early (This is a topic for another day)
#10 REGULATED BINARY OPTIONS EXCHANGE
There are 2 types of binary options:
a. Regulated Exchange
b. Unregulated Bucket Shop
A regulated exchange is a trading exchange just like the New York Stock Exchange. They have to endure fierce regulations by the U.S Commodity Futures Trading Commission. Regulated Binary Options Exchanges are held to the highest standards in trading and clients are under the same protections as if they were buying a futures contract, a stock in a company, or a traditional option. They also hold your money in segregated accounts so in the event the exchange failed, your money will be safe.
Currently, there are only 2 regulated binary options exchanges for U.S. citizens.
a. Cantor Exchange
b. North American Derivatives Exchange
Let’s talk a minute about what I like to call ‘Unregulated Bucket Shops’… Have you ever seen advertisements like:
100% bonus just for signing up with us!
Trade 60 second lightning options!
Binary broker offers 100% winning signals
All this is bunk, unregulated, and dangerous. If you are ‘trading’ with these types of businesses, you are setting yourself up for failure. These are not brokers, even if they call themselves brokers. They are businesses that want you to fail.
Here is a common sense reason to stay away from bucket shops:
Let’s pretend I owned Ryanherronbinaryoptions.com and allowed you to trade against me. Why, Oh Why would I want you to succeed? If you make money I lose money. It makes absolutely zero sense.
If you trade with these types, you are NOT trading against other traders. You are trading against the house in a similar way casinos do it. Casinos want you to fail but they market their products with excitement in the hopes to lure in money. The same goes for all the bucket shops out there. They want you to fail. If you fail, they win. It’s as simple as that.
If you take their ‘BONUS’, you are most likely doomed to failure already because hidden in the fine print, you may notice that you have to make, sometimes 1000% in your account before you can ever withdraw a single penny. So the unsuspecting trader deposits $1,000 and before he can withdraw, he has to make ungodly profits before he is off the hook.
There are stories after stories all over the place where people could not get their money back. There are brokers that ‘create’ false price spikes in order for you to lose. What happens if the business goes under? WHat happens if the business decides to just shut its doors one day. Will your money be safe?
Last words… Binary Options are awesome! If you are going to trade them, please, for the love of all that is pure, trade with a regulated binary options exchange. If you are interested in finding out more about binary options or any other type of trading, sign up for a free account at joaquintrading.com and take a tour.