In-depth Analysis of Binary Options
What are binary options?
Binary options are:
“In finance, a binary option is a type of option where the payoff is either some fixed amount of some asset or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option.”
-Cantor Fitzgerald
“The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. Thus, the options are binary in nature because there are only two possible outcomes. They are also called all-or-nothing options, digital options.”
-Wikipedia
“A type of option in which the payoff is structured to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money. The success of a binary option is thus based on a yes/no proposition, hence “binary”. A binary option automatically exercises, meaning the option holder does not have the choice to buy or sell the underlying asset.”
-Investopedia
If after reading these 3 definitions it is still not clear for you what binary options are, fear not. Let me help you with these two examples.
Types of binary options
Call/Up binary option
This type of binary option is called “call” in Europe and “up” in America.
Let me illustrate with an example how a call option looks like in practice:.
Example:
I’m buying a call option on the shares of Simon Co. (Nasdaq: SIM) for $ 500. The call option has a maturity date of 2015 January 1. and if the stock SIM ever trades over $ 899 per share (spot value) before 2015 January 1. I get $ 5000 at 2015 January 1.
If the spot goes over the strike (above $ 899 per share) before the maturity date (2015 January 1) I will get the value of the call option ($ 5000) at the maturity date and if the spot never goes over the strike I get nothing (and lose $ 500 buying this call option).
/spot, spot value: the current value of the share/
/strike: the predetermined limit, which the spot needs to reach for you to recieve the value of the option./
/maturity date: in the world of binary options maturity date means that you will receive the predetermined value of the call or put option at the maturity date if the criteria for the payment( spot goes over the strike) is met before you reach the maturity date. Payment will be sent at maturity date. /
Put/down binary option
This type of binary option is called called “put” in Europe and “down” in America.
Let me illustrate with an example how a put option looks like in practice:
Example:
I’m buying a put option on the shares of Simon Co. (Nasdaq: SIM) for $ 500. The put option has a maturity date of 2015 January 1. and if the stock SIM ever trades under $ 899 per share before 2015 January 1. I get $ 5000 at 2015 January 1.
If it never reaches or goes above $ 899 per share I will get nothing (and lose $ 500 buying this call option).
Sometimes there is no strike value at all and some binary options websites let you buy an option where it is enough to specify the direction of the stock price, whether it will decrease or increase by the time of the maturity date (i.e if the stock worth more/less by the time your binary option expires.).