Options trading has become extremely popular among retail stock traders over the past decade. One new, controversial cousin of the traditional stock option contract has gotten a lot of attention in the past couple of years: binary options.
What Is A Binary Option?
Like a traditional stock option contract, a typical binary option contract is a bet that the price of a stock or other asset will be above/below a specific strike price at a specific time in the future. However, the key to binary options is that there are only two possible outcomes if the contract is held to expiration: profit a specific, predetermined amount, or lose 100 percent of the investment.
How Does A Binary Option Work?
The most common type of binary option is a “high-low” option. A typical high-low option works like this: A trader starts with a belief that a stock price will rise or fall within a certain amount of time. For example, imagine that Bank of America stock is trading at exactly $17.00 with 15 minutes left in the trading day. A binary options trader that believes that Bank of America will finish the day above $17.00 might buy $100 of binary “call” options for Bank of America with a strike price of $17.00 and a 70 percent payout.
If this trader buys and holds these options until they expire (15 minutes later), one of two things will happen: either the stock will close above $17.00 and the trader will profit $70, or the stock will close below $17.00 and the trader will lose $100. Regardless of whether the stock closes at $17.01 or $17.51, the binary option only pays out the predetermined 70 percent rate.
What Are The Pros Of Binary Options Trading?
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