Binary options trading is a type of investment where the investor forecasts that on a certain date, an asset will have a certain price.
If he investor makes a correct prediction, he gets a fixed amount of cash from the other party. Otherwise, he will get none. Even if this method has lower risks in comparison with traditional options trading, investors must still study the condition prior to deciding if there is a healthy balance between risk and reward.
What’s most important to consider with binary options trading is the condition of the option. The terms are quite unique from those that used in other common financial trading types.
Investors should check as well if the option is European or American style. Whatever the terms, there is no restriction to particular markets in terms of styles. With the European style (the more common style), the price should be either above or below level on the designated date. The American style option has a greater chance of giving a payout and this is usually seen in the pricing.
Similar to other options, investors who are using binary options trading must answer two independent questions. First, what are the chances that there will be a payout? Second, how does the option’s pricing indicate this possibility? It’s important to bear in mind that pricing is not all about the amount the investor pays initially; instead, it is the balance between the amount paid to have the option, and the amount to be received when the option pays out. In gambling, this is tantamount to fixed odds.
It must also be checked if a binary options trading transaction is for cash, or if it is for assets. With an asset transaction, payout will come as a fixed asset (for example, a certain number of shares). In European style, the investor could end up making more money than expected, but this depends on how much the excess is on the designated level on the designated date. This possibility must be taken into account before deciding if an option makes sense.
Many investors utilize a formula in assessing an option’s value. While the formula itself is objective, choosing it is, of course, subjective. The most popular is the Black Scholes model. There are variations here, depending on whether the option is based on cash or based on asset, and if it’s a put or a call.
In any case, the formula will consider the stock’s present price, the level of payout, how long before the agreed date, and asset price volatility. The formula also considers the present interest rate for zero-risk investing, like government bonds.