Binary options (also called digital options) are relatively new financial instruments which enable traders to benefit from both rising and falling prices. Unlike traditional options, binary options can be traded even with very little trading capital, thus they are especially interesting for beginners.
How do binary options work?
The term “binary” already signals the simple operating principle of these trading instruments. A binary option can have only two conditions, namely “in the money” and “out of the money” – similar to the digital conditions “1” and “0”. Thereby it is only important whether the option is in or out of the money at the end of the option period (expiry date).
Does the trader expect rising prices, he buys a call option. With put options one can bet on falling prices accordingly. For a winning binary options trade, prices have to be higher (call option) or lower (put option) than the entry price at the end of the option period. With binary options trading, traders simply make a decision regarding the direction of the price movement of an asset. The asset acts as a so-called underlying for the binary option. For example, the forex-pair EUR/USD serves as underlying asset of the binary option in the graphic below.
The price of the underlying asset at the end of the option period is therefore crucial in determining whether the trader earns money or suffers a loss. If the trader is right in his assessment of the market, then the option will expire “in the money” and a pre-defined return is paid out by the broker. In classic binary trading, a return between 65% and 85% of the initial stake is offered, depending on the broker. In case of a loss many binary options trading platforms offer a refund of up to 15% as a compensation. Binary options can usually be traded with low initial stakes starting from 10 to 25 USD per trade. A detailed overview of the minimum initial stakes and refund rates can be found in our comprehensive broker comparison.
High yields and calculated risk
Different trading modes and supplementary functions
Now that the basic questions “what are binary options?” and “how do binary options work?” are answered, let's move on to binary options trading modes and supplementary functions in order to take a closer look at the various possibilities in binary options trading.