What is a binary option?
A binary option or digital option is a form of a financial option. It is a complex variant of the standard financial option, with usually different contract specifications. A digital option pays out a fixed amount or nothing at all when the option expires. This is in contrast to ordinary options that become more valuable as they become more in the money.
An important difference between ordinary options and binary options is that binary options never become the property of the investor. The investor can only speculate on the price of a financial product. The financial products that can be traded with binary options are mainly in the categories: currencies, stocks, commodities or indices.
Binary options are a risky investment product with a low financial and technical entry threshold. They are offered online via various channels.
Types of binary options
There are two types of binary options: high / low and one touch. At high / low we still distinguish the call option and the put option. The call option turns off when the price rises, the put option turns off when the stock market falls. In case of profit, the deposit is refunded and a predetermined return (often 80% or more) is paid out.
The one touchknows two scenarios at expiration time: ‘in the money’ and ‘out of the money’. When the option is closed, the investor predicts whether the price will reach a certain level before the expiration time has been reached. If the option reaches that level (‘in the money’), the contribution plus the return is paid out. If the option does not take that level (‘out of the money’), the investor loses his stake. One-touch options are riskier; here, therefore, a higher return applies than for high / low options.
Aspects of binary options
There are three aspects that are the same for every type of binary option. These are the following aspects:
- Expiration time (expiry time)
- Starting price
- Payout offer
The expiry time is the amount of time from the moment that the investor definitively ‘buys’ the option until the option contract closes. Expiration times differ per binary option broker, in English also called “broker”. The expiration time can vary from 60 seconds to a long term, whereby even investments can be made on binary options with an expiration time that is far in the future. After the close of the expiration period, the investor ends ‘in the money’ or ‘out of the money’.
The starting price is the value of the price of the financial product, at the moment of the definitive “buying” of the binary option by the investor. If, for example, in the binary option high / low for a call option is chosen, the price of the financial product at the end of the expiry time must be higher than the starting price to end ‘in the money’.
The remuneration percentage is the percentage that the binary options broker offers to the investor when the investor ends ‘in the money’. In binary options, these percentages vary, often depending on the risk of the investment. The remuneration percentage for binary options is known before the investor proceeds to ‘buy’, so that the investor knows in advance what the risks of the investment are.
High / low
An investor will pay a binary call option on the AEX for 100 euros at a pre-determined return of 80%. At the time of closing, the AEX notes 500 points. If, at the end of the term of the option, the AEX index exceeds 500 points, the holder of the call receives his 100 euros plus 80 euros return. If the AEX is lower, it will not receive anything. In the unlikely event that the AEX remains at the same level, the investor usually gets his deposit back.
An investor closes a binary option for 100 euros on Apple’s shares at a pre-determined return of 125%. The stock has a value of 500 at the time. The investor predicts that the value of the Apple share will exceed 520 in the coming week. The expiration time is therefore one week further, the option is bought at 520. If the Apple share is higher than 520 in that week, the investor will receive 225 euros (100 euros deposit plus 125 euros yield). If the Apple share does not exceed 520, the investor will receive nothing.