A Walkthrough of the Binary Options Trading Process in the United States
Binary options are a type of financial option that offer either a fixed payoff amount or no payoff at all if the contract is held until its expiration date. Because there is no other type of settlement that can occur, these types of options are referred to as binary options. A binary option is based on a straightforward yes-or-no proposition, namely, will an underlying asset’s price be higher than a particular threshold at a predetermined point in time?
It is one of the simplest financial assets to trade because traders place bets based on whether they feel the answer is yes or no. Because of this simplicity, it has garnered a lot of interest from traders as well as others who are just starting out in the financial markets. Traders should have a comprehensive understanding of how binary options function, what markets and time frames they can trade using binary options, the benefits and drawbacks of these products, and which companies are legally authorized to supply binary options to residents of the United States.
The structure of binary options that are traded on exchanges located outside of the United States is often distinct from that of binary options that are traded on exchanges located within the United States.
1 Binary options are an alternative to speculating or hedging, but the trader should only consider using them if they have a complete understanding of the two different outcomes that are possible with these exotic choices.
KEY TAKEAWAYS
• Binary options are options that pay out either a fixed sum or nothing at all depending on whether or not the option is kept until it expires. These options are based on a yes-or-no proposition.
• The Nadex is the marketplace for trading these options, which come with the option of having either capped risk or capped potential.2
• The bid and ask prices are determined by individual traders after they determine whether or not the likelihood that was presented is accurate.
• The cost to enter and leave a transaction on Nadex is the same, at $1 per contract.
A Guide to Binary Options in the United States
The trading method known as binary options is based on a simple yes or no proposition and limits both the amount of potential loss as well as the amount of potential gain.
Take, for instance, the following inquiry as a point of reference: When 1:30 p.m. rolls around today, will the price of gold be higher than $1,830?
If you believe it will be, you buy the binary option. You should sell this binary option if you believe the price of gold will be at or below $1,830 at 1:30 p.m. on the current trading day. A binary option’s pricing is always somewhere between zero dollars and one hundred dollars, and just as in other financial markets, there is a bid price and an ask price.
At one o’clock in the afternoon, the aforesaid binary may be trading at a bid price of $42.50 and an offer price of $44.50. If you decide to buy the binary option right then, the total cost, minus costs, will be $44.50. In the event that you make the decision to sell right at that moment, the selling price will be $42.50 (before costs).
Let’s imagine you decide to buy at $44.50. If the price of gold is higher than $1,830 at 1:30 p.m., your option will be deemed to have expired and will be worth $100. You have a profit of $55.50, which is equal to $100 minus $44.50. (minus fees). Being “in the money” refers to this state of affairs. But if the price of gold is below $1,830 at 1:30 p.m., the option expires at $0. Therefore, you will lose the $44.50 that you initially invested, in addition to any fees. This called out of the money.
Both the bid and the offer are subject to change up until the option is exhausted. If you want to lock in a profit or reduce a loss, you can close your position at any moment before the option expires. This is preferable to letting the option expire out of the money. 4
A Zero-Sum Game
At some point, the value of each option will either settle at $100 or $0. One will receive $100 if the proposition underlying the binary option turns out to be accurate, while the other will receive $0. Because of this, the total value of each binary option has the potential to reach $100, but the game has no winners or losers because it is a zero-sum game: whatever you win, someone else loses, and whatever you lose, someone else wins. 4
Each participant in the trade is responsible for providing their own capital for the transaction. In the situations that were just presented, you paid $44.50 for an option, and then someone else sold you the option. Your maximum loss would be $44.50 if the option were to settle at zero, and the total cost of the trade, less any fees, would be $44.50. If the option is exercised and the price is $100, the person who sold it to you will have a maximum risk of $55.50—$100 minus $44.50 equals $55.50, without any fees.
If they so choose, traders are able to purchase numerous contracts. Another illustration would be as follows:
• S&P US 500 index > 4405.2 (4:15 p.m.).
The current bid and offer are each set at $18.00, while the starting price is $24.00. If you believe that the index will be higher than 4405.2 at 4:15 p.m., you may either submit a bid at a lower price and hope that someone would sell to you at that price, or you can buy the binary option for $24 if you think the index will be higher. If you anticipate that the index will be lower than 4405.2 at that time, you should sell at the price of $18. Alternatively, you might make an offer that is higher than that price and hope that someone will buy it from you.
You come to the conclusion that the index will be trading at a level higher than the “strike price” of 4405.02 by 4:15 p.m. and make the decision to buy at the price of 24. You also have the option to sell multiple contracts in the event that you are enthusiastic about the trade.
A transaction to acquire one contract (size) at $24 is depicted in Figure 1. When you place an order, also known as a ticket, on the Nadex platform, the platform will automatically compute your maximum loss and gain, maximum return on investment (ROI), and probability of being in the money (ITM). 5
Trade Ticket for Nadex, Including Maximum Profit, Maximum Loss, and Probability of Being in the Money
Taking into account any applicable fees, the highest possible profit on this ticket is $76 while the most possible loss is $24.
The Establishment of the Bid and Ask Prices
Traders evaluate the likelihood of the proposition being true or false, and based on their conclusions, they decide what the bid and ask prices will be. If the bid and ask on a binary option are at 85 and 89, respectively, then traders on the buy-side are assuming a very high probability that the outcome of the binary option will be yes, and the option will expire worth $100 for buyers. To put this another way, if the bid and ask on an option are at 85 and 89, respectively, then the simple explanation is as follows: When the bid and ask are close to 50, traders are uncertain as to whether the binary option will expire at $0 or $100 because the odds are fairly even in either direction.
If the bid price is 10 and the ask price is 15, respectively, this suggests that traders on the sell-side of the market believe there is a high probability that the option outcome will be no, and that the option will expire worth $100 to sellers. The buyers in this region are willing to accept a moderate risk in order to realize a significant reward. Those who are selling are willing to forgo a larger potential return in exchange for a smaller but more certain profit (relative to their gain).
Where to Engage in the Trading of Binary Options
The Nadex exchange was the first legal U.S. exchange that was focused on binary options, and it is where binary options trade. The North American Derivatives Exchange (Nadex) offers its own binary options trading platform that is browser-based. Traders can gain access to this platform through either a demo account or a live account. Real-time charts and direct access to the market for checking out the most recent prices for binary options are both offered by the trading platform.
The North American Derivatives Exchange (Nadex) is where trading in binary options takes place.
The Chicago Board Options Exchange additionally provides access to the binary options market (CBOE). Traders that have a brokerage account that is approved for options trading are able to trade binary options on the CBOE using their standard trading accounts. Trading in binary options is offered by some brokers but not all of them. 6
Costs Associated with Binary Options
Each Nadex contract that is exchanged has an entry fee of $1 and an exit fee of $1.
If you keep your trade open until settlement and end up profitable, the fee to exit will be deducted from your account at the expiry time. If, on the other hand, you decide to hold the transaction to settlement but end up with a loss, you won’t be charged a settlement fee. 3
Trading occurs in CBOE binary options through a number of different option brokers. Every one of them has their own unique commission rate.
Choose Your Binary Trading Market
Trading binary options allows for transactions in a wide variety of asset classes. Trading in key indexes such as the Dow 30 (also known as the Wall Street 30), the S&P 500 (also known as the US 500), the Nasdaq 100 (also known as the US TECH 100), and the Russell 2000 is available through Nadex (US Smallcap 2000). There are also global indexes available for the country of the United Kingdom (FTSE 100), the country of Germany (Germany 40), the country of China (China 50), and the country of Japan (Japan 225). 7
The following currency pairings are available for trading: EUR/USD, GBP/USD, USD/JPY, EUR/JPY, AUD/USD, USD/CAD, GBP/JPY, USD/CHF, EUR/GBP, AUD/JPY, and USD/MXN.8
Binary options on commodities such as crude oil, natural gas, gold, and silver are among the options that can be traded on Nadex.
Event binary options allow for trading of news events as well as other types of events. Whether the Federal Reserve will raise or lower interest rates, or whether unemployment claims and nonfarm payrolls will come in above or below consensus predictions, traders can decide whether to buy or sell options depending on these factors.
Choose Your Own Adventure Within This Time Frame
A trader has the option of selecting Nadex binary options (in the asset classes described above) with expiration times of either intraday, daily, or weekly.
Day traders have the potential to earn a predetermined return through the use of intraday options, even when market circumstances are relatively calm, provided that they correctly predict the direction in which the market will move during the given time period.
Daily options are excellent for day traders or investors who want to hedge other stock, FX, or commodity holdings against the moves that occur on that particular trading day because they expire at the conclusion of the trading day.
As a result of the fact that weekly options expire at the end of the trading week, swing traders trade them throughout the week, and day traders trade them as the expiration time of the options gets closer to being reached on Friday afternoon.
Because event-based contracts become null and void following the dissemination of the formal announcement linked with the event, all manner of traders take positions well in advance of, and right up until, the expiration date.
Trading Volatility
There is a strong correlation between the way binary options are priced and any perceived volatility in the market that the options are based on.
Take the following illustration, for instance. Will the EUR/USD exchange rate be higher than 1.1815 with 1.5 hours left until the contract expires, despite the fact that the EUR/USD currency pair is currently trading at 1.1825? On a day with minimal volatility, the spot EUR/USD exchange rate may have relatively little expectations of movement, and the cost to purchase or sell a contract may be in the range of $90. The EUR/USD pair is already 10 pips ahead of the money, but it is anticipated that the underlying market will remain unchanged. Therefore, there is a good chance that the buyer will get a payout of one hundred dollars.
The cost of buying or selling the contract will get closer to $50 if there is a lot of fluctuation in the EUR/USD exchange rate during a volatile trading session. This is because the probability of the underlying market price remaining above the 1.1815 strike is lower when there is the possibility of a larger market move.
Binary options include both positives and negatives.
The risk associated with binary options is limited, in contrast to the actual stock and currency markets, which include the potential for price gaps or slippage. It is impossible to incur losses that are more than the whole cost of the deal, which includes all expenses.
Even in extremely calm markets, it is feasible to make returns that are above average. It can be difficult to make a profit when a stock index or currency pair is barely moving; but, the payment for a binary option is always known in advance. If you spend $20 in a binary option and it ends up settling at either $100 or zero, you will either earn $80 on your initial investment of $20 or suffer a loss of $20. This presents an opportunity with a reward to risk ratio of 4:1, which is highly unlikely to be seen in the underlying real market that the binary option is based on.
The negative aspect of this is that there is a limit placed on the amount of profit you can make. The most money that can be made from a binary option is $100, and this amount cannot be increased no matter how much the underlying stock or FX pair rises in your favor. One strategy to potentially increase one’s profits from an anticipated price movement is to purchase many options contracts.
Binary options have a maximum value of $100, which makes them accessible to traders even with low trading capital because typical stock day trading limits do not apply to binary options and do not apply to regular stock day trading. You won’t be charged anything to create a live account. There is not a mandatory minimum deposit amount. 12
Binary options are a type of financial derivative that are based on underlying assets that the investor does not directly own.
13 As a result, you do not have the right to vote or earn dividends, even though you would have those rights if you owned actual shares in the company.
Pros
• There is a limit on the risks.
• Better than average returns.
• The payouts have been determined.
Cons
• There is a limit on gains.
• Derivative-based investments can be highly unstable.
• The United States only offers a restricted range of binary options to choose from.
The Crux of the Matter
Binary options can only be exercised in accordance with a yes-or-no proposition. Your potential for profit or loss is dependent on the price at which you buy or sell the option, in addition to whether or not it will expire worth $100. You can leave an option at any time before it expires, giving you the ability to lock in a profit or decrease a loss and limiting both the risk and the potential reward.
Nadex and CBOE are the two exchanges in the United States that are used for trading binary options. Generally speaking, businesses located outside the United States that are engaging in criminal activity when they approach people living in the United States with the intention of getting them to trade their version of binary options. 1 Trading binary options has a low entrance barrier, but the fact that something is simple does not guarantee that it will be easy to make money with. There is always someone else on the opposite side of the exchange that feels they’re correct and you’re wrong.
You should only trade with money that you can afford to lose, and you should practice trading using a demo account before you trade with real money so that you can get entirely comfortable with how binary options work.