Also known as digital option or all or nothing option, binary option is a trading instrument with a fixed return that is decided at the onset of the trade. If a binary option expires in the money, a trader gets a predetermined payout and if the option expires out of the money, he will lose a predestined amount of his initial investment and receive nothing.
Unlike traditional options, there are no set prices in binary options, the amount of money the trader wants to risk is determined by him and he invests that amount when purchasing the option. It does not matter how much the option is in the money or out of the money as it happens with a traditional option. However, in binary options trading or fixed payout trading a trader receives between 60-70% payout if the trade is in the money. While a return of 15% of his investment if the trade is out of the money. This amounts to a total loss of 85% of his investment.
A powerful formula that the traders can use while trading binary options is the hedging strategy. Using this strategy, one can create a profit zone with an overall positive expectation. If a trader places a put (sell) option over a call (buy) option, he can virtually guarantee at least one profitable trade. Due to trading negative profit anticipation, a simultaneous loss or win will result in a 15% loss while win will result in 60-70% profit.
A potential gain of 60-70% in comparison to a potential loss of 15% is far better than a potential loss of 85%. Here is an example to explain how this can be done. A trader places a call option in an uptrend. He will realize a profit at the time of expiration as long as an uptrend remains. But if in any case the trend reverses, it is the ideal chance for the trader to place his profit zone trade. He can do so by simply placing a put option in the track of the trend reversal. The trader will receive by and large a profit if 60 to 70% of his investment as long as the expiration price is above his call option strike price but below his put option strike price.
If one of the trades expires out of the money, the trader suffers a loss of 15%, presuming that both the trades are of the equal size. With these odds, the trader is only required to win about 25% of his trade, in order to make a profit. Without this powerful strategy, a trader would have to win over half of his trades. Since the set up won’t occur every time but as long as the trader always trade into a strong trend and remain attentive for potential reversals, he ought to see an overall profit trading Forex binary options.
Binaries can be traded on stocks, commodities and indexes but due to accessibility of technical analysis tools and free charting packages for currency traders, they perhaps concentrate more on the Forex market trading.