If you are you win back your bet and plus a pre-agreed amount. If youre wrong you lose almost all of your 100.Of course its not as simple as that. In fact, theres serious math behind binary options and people who engage in binary options trading, like all others involved in financial markets, are pretty confident that their numbers are better. Because in a single binary option trade, the outcome for the participants is also binary. One loses, one wins.First, there is an underlying asset, the future value of which becomes the basis for the trade. This asset can be the price of a specific companys stock. It can be a traded commodity such as gold. Recently, there was an industry filing at the Commodities and Futures Trading Commission to allow exchanges to offer binary options for future box office receipts of certain films.Second is the direction of trade. This is your guess of what the price of the asset will be at a specific point of time in the future and you make your trade based on whether this price will be above or below the current price at the time that the binary options contract was made. Third is, of course, the amount you wish to trade.Call option. The right to buy. In binary options trading, the purchase of an offer is an exercise of the option. In American exchanges this is termed as Finish High because the motivation behind a call is the probability that the price of the asset when the contract expires will be higher.Put option. The right to sell. This is also exercised when the offer to sell an option is taken. This is called Finish Low in American exchanges because a put is based on projections that the price of an asset will be lower when the contract expires.Essentially, options is a misnomer for these types of transactions. Lock (another type of derivative) would have been the more appropriate term because once the deal is sealed, both buyer and seller are obliged to comply with whatever conditions were agreed upon to take effect at the contracts expiry.One other thing to remember is that trading in binary options only involves the price of underlying asset, but not the asset itself. You might be trading binary options for the price of Google or Apple stocks or gold, but there is no assumption that the seller owns any of these assets or that that you will when the contract expires.Fixed risk and reward. Most binary options are Fixed Return Options (FROs) in which the gains and losses (the risk-reward ratio) are predetermined. You know exactly what youll earn should you be in-the-money, or what you would otherwise lose if you happened to be out-of-the-money. In a 100 trade, for example, many options offer a return of 81 for a successful trade. Many also offer to return 10 of the purchase amount should your trade be out-of-the-money.High level of sophistication. While easier to understand than most options, binary options still offer enough freedom for the application of sophisticated investment strategies. Investors in the forex market use binary options to hedge against their currency investments by investing in an opposite direction to their traditional forex position. Regardless of whether prices rise or fall, theyll have their losses covered or might even profit from their binary options position.Potential to profit from both falling and rising markets. In regular stock and commodity markets, money is made only when the price of the asset is rising. Binary trading allows an investor to absorb some of the markets risk and make money regardless of whether prices are falling or rising.Binary options can either be cash-or-nothing, where a fixed amount of cash is paid out. It can also be an asset-or-nothing option where instead of cash the value of the underlying asset is paid out. Aside from these basic types, there are other more exotic binary options that are a bit more complex but follow the same general concept.Barrier options are options that depend on a specific price level for their existence within the duration of the options contract. They can disappear (knocked out) or appear (knocked in) when a specified price level is breached. In partial barrier options, the price is monitored only for a specific window within the duration.In a double barrier option, there is both an upper and lower price barrier and the double knock ins are activated or a double knockout terminates the option if any of those barriers are hit. The more complex double barrier binary option, of which there are 28 types, combines the characteristics of both barrier and binary types.As with any other form of investment, risk is inherent in binary options. In fact, websites that guarantee returns are the ones you should stay away from. There have been complaints of payoffs not being remitted to bank accounts, so youll need to do due diligence before committing.If youre serious about trying binary options trading out, selecting a reputable trader is the first critical step. There has been a proliferation of trading websites online and it can be quite confusing to know which is legit and which is not. Start with traders registered with the Chicago Board Options Exchange (CBOE) or the American Exchange (Amex) to be sure that the firm youre dealing with is subject to regulation. Fixed return options are more common in Europe and are traded in European exchanges heavily, thus the nickname European options. There have been reports of Europe-based sites engaging in unauthorized binary options trading.The financial crisis of 2008 has awakened every American to the very real threat Wall Street presents to their personal financial health. The clamor for financial reform has resulted in the Dodd-Frank Act being passing into law in 2010. However, regulation for binary options trading is not explicit in the implementing rules and guidelines although proposals for rule changes have been discussed in the Securities and Exchange Commission (SEC) and predate the creation of the Dodd-Frank Act. For now and until the rules are in place, prudence in this investment area will always be your biggest safety net.Forbes columnist Gordon Pape issued a strong warning against binary options. He claims that this form of trading appeals to the online poker crowd and market junkies who tend to be more exuberant in taking chances than the ordinary investor.
