Options trading tends to confuse many people, especially people who are new to investing and trading. Although there are complex formulas involved in options trading, almost all of this happens behind the scenes and the person doing the trading doesn’t really need to know anything. In theory, options are very simple: they basically consist of a bet that, from a certain time in the future, the price of a share will be higher or lower than a specified price (called strike price).
So people try to profit from buying and selling options the same way they try to profit from buying and selling stocks, with different strategies depending on whether they think the price will go up or down in the future.
Some of the complicated formulas come into play when pricing options. The price of an option will constantly change as the price of the underlying stock changes, and there is also something called a “time premium” built into the value of an option. This basically means that the longer an option has until expiration, the more extra price is added to its price. When you think about it, this makes sense because an option with an expiration date far in the future has more time available for the price of the underlying stock to exceed the strike price of the option. In other words, an option expiring in 5 minutes only has 5 minutes left for the price to exceed its strike price (if it hasn’t already), but an option expiring in 5 days has a lot more chances of that happening.
Binary options are a specific type of options that pay “all or nothing” based on the price of the underlying stock at expiration.
There are several reasons a trader may wish to consider binary options, and these include:
Simplified profitability – if the stock price is higher than the strike price at expiration, you get paid. If not, you don’t. No crazy formulas to follow.
Limited risk – all possible outcomes are known in advance, so there are no possible surprises where you might owe people more money than you initially invested (which happens from time to time with trading of options, and one of the reasons why people tend to think “options can be dangerous.”
Availablity – as binary options become more and more popular, more and more brokers offer them to traders.
Remember to always read your broker’s terms before you start trading.
Comments are closed.