Binary options. Features, advantages and disadvantages.
The rapid growth of financial markets in recent years has led to the emergence of a huge variety of different financial instruments. Only a few years ago, a retail trader had access only to currency and share transactions, but nowadays the range of financial instruments has expanded significantly. All sorts of options, futures, stocks, bonds, P&Fs – this is a very incomplete list of possible investment options for a beginner or professional trader. Options deserve special attention from this list, especially so-called binary or digital options, which allow you to quickly profit from directed movements in different markets
According to the definition, a binary option is a type of option that either generates a fixed return if the price of the underlying asset is better than the market price at the time the option expires, or it generates nothing (in the opposite situation). The word “option” often puts novice traders into a stupor, and they immediately refuse to work with this trading instrument. In fact, however, everything is much easier than it seems, despite the significant differences between binary options and their classical colleagues
An option is a derivative financial instrument that allows the buyer (seller) to acquire the right to buy (sell) a certain product at a predetermined price for a certain period of time
The buyer and the seller of the option can conclude a contract for the purchase of 100 shares of Microsoft for $ 100 apiece before the end of the month. In this case, the underlying asset of the option is Microsoft shares, and the expiration date is the last working day of the current month. During this month, the buyer of the option has the right to purchase 100 Microsoft shares from the seller at $100 each, regardless of their current value. For example, if by the end of the month the shares increase to $120 per share, the buyer of the option can “exercise” it and buy 100 shares from the seller at $100 each, which will bring him a profit of $20 per share, and the seller of the option will suffer proportional losses. If the value of the shares is lower than $100, it is more profitable for the buyer to allow the option to expire unexecuted. In this case, it will lose the paid option premium and the seller will receive a profit in the amount of the paid option premium
Option premium – the amount paid by the buyer (seller) of the option when concluding the option contract. The amount of the option premium is usually set by the organizer or broker and directly depends on the volatility of the underlying asset, i.e. the higher the volatility, the higher the risk and, accordingly, the amount of the option premium.
Thus, the value of the option for the buyer is equal to the option premium, and the exercise value of the option is composed of the predetermined value of the asset multiplied by the predetermined number of assets purchased and the option premium. Suppose the buyer buys an option for 100 Microsoft shares at $100 per share and the option premium is $10 per share. As a result, the cost of concluding an option contract will amount to 1000 dollars, and the cost of option execution – 100*100+10*100 = (100+10)*100 = 11000 dollars. If the value of the shares exceeds $110 before the expiration date of the option and is, for example, $120, the buyer can exercise it, resulting in a profit of $1000 ($120*100 – $110*100=1000). If the value of the shares does not exceed $110, for example, it is more profitable for the buyer not to exercise the option, as a result of which he will lose the paid option premium of $1000, which will move into the pocket of the option seller
The above description of the mechanism of pricing and practical use of options is somewhat simplified, but it is quite sufficient to understand the principles of using binary options. As the name implies, “binary” options imply the presence of only two results for a trader – either a fixed profit or its complete absence. This principle differs significantly from simple options, in which the amount of profit depends on the value of the underlying asset at the time the option is exercised. For binary options, the amount of profit is predetermined and the criterion for earning it is whether the value of the underlying asset exceeds or does not exceed the threshold level
For example, if a trader buys a binary call option on Microsoft shares (call option) for $11 (option premium) with a declared payout of $20 and strike price of $100 (threshold level), then:
1) If the Microsoft share price exceeds $100 at the time the option expires, e.g. $101, the trader receives $20. Even if the price is even higher, for example $150 per share, the trader will still get only $20. Trader’s net profit will be 20-11 = $9.
2) If the Microsoft share price seems to be below $100 at the time the option expires, the trader receives nothing. Thus, the trader actually bears losses in the amount of the paid option premium, i.e. $11
Binary Options or Forex?
At first glance, it may seem that the trader’s task is much easier than trading on the stock or financial market – he only needs to guess the direction of the underlying asset within a certain, usually very short period of time. However, when looking deeper, binary options trading is not much different from other, more traditional markets, as the trader also needs fundamental or technical analysis to determine the current trend. Without analytical skills trading binary options turns into flipping of a coin in order to guess the winning outcome.
However, binary options can be useful for beginners, as the risk of trading with this financial instrument is strictly limited by the option premium, which allows the trader to avoid unplanned losses in case of strong directed movement against an open position. In the financial or currency market, it is the psychological inability of the trader to accept losses that is the main cause of failure, and in the case of binary options, the losses are already limited to a certain fixed amount paid by the trader at the time of purchasing the option
Binary options for Russian and CIS residents
In the Russian context, binary options trading is very risky, as most brokers offering services in the industry do not have any regulatory licenses and can set their own prices for the underlying options assets regardless of the current market prices. That’s why when choosing a broker, the issue of its reliability, i.e. the availability of any licenses that guarantee fair treatment of clients, comes to the fore
Let’s consider some of the most popular brokers working in the Russian Federation:
There is no doubt that Anyoption has a license, but the company does not specify what it has been granted a license for. On ru.anyoption.com you can find the following wording
anyoption is a fully regulated trading platform that complies with the strictest regulatory standards set by CYSEC (Cyprus Securities and Exchange Commission). Our platform is fully transparent, subject to EU amendments such as the MiFID (Markets in Financial Instruments Directive), and reviewed by KPMG.
It is not clear what is licensed – the company’s activities or its trading platform. Either this is the cost of translation, or the specific presentation of information for a specific purpose. The fact that the company’s work is subject to EU and MiFID (rather than LICENSED) amendments does not mean anything at all, similarly, the work of a train driver can also be subject to EU and MiFID amendments and many other organizations, which does not impose any obligations on him.
Despite the above mentioned discrepancies, this broker has been working on the binary options market for a long time and has managed to take one of the top places among Russian traders. It is worth mentioning that, according to the assurances on the pages of the company’s website, the main source of price data is the respected agency Reuters, which reduces the likelihood of any manipulation with the quotes of basic options instruments.
The virtues of anyoption:
- Ultra-short-term option transactions are possible;
- Large selection of underlying assets for trading operations;
- Good Russian-speaking support
- The source of price data is Reuters.
Shortcomings in anyoption:
- Poor quality of translation of the Russian-language version of the site;
- Very confusing navigation through the site, inability to quickly find trading conditions and other important information;
- Unclear wording on licensing;
- Absence of the Russian regulator’s license.
24option also does not have any licenses from Russian or European regulators. The information on licensing of the activity of this company is as follows:
24option.com is a brand owned and operated by rodelerlimited, a Cypriot-registered financial services company (he312820), which has received a license from the Cyprus Securities Exchange Commission under the number 207/13 and is also subject to the regulation of this commission. The address of rodelerlimited is 67 spyroukyprianou, potamosyermasoyia, limassolcy-4043.
At least this broker has provided more specific licensing information than anyoption, but the wording is also not very clear. However, 24option is also one of the top three brokers
The virtues of 24option:
- High payouts on profitable trading operations;
- Availability of training materials after registration and deposit of funds;
- Convenient interface of the trading platform;
- Intuitive website of the company, which allows you to easily get all the necessary information;
The drawbacks of 24option:
- High (relative to other brokers) minimum deposit;
- The existence of a license for only one organization, and the information about the license is rather vague;
- Absence of the Russian regulator’s license.
TopOption is also licensed in Cyprus, and the company’s offices are located there:
TopOption is a trademark of Safecap Investments Ltd. It is a financial services company licensed (No. 092/08) by the Cyprus Securities and Exchange Commission. Safecap Investments Ltd has offices at Treppides Tower, Kafkasou 9, Aglantzia, P.O. Box 26522, CY 2112, Nicosia, Cyprus.
The information about the license is specific, but the absence of a Russian regulator’s license is a barrier in case of a legal settlement of possible claims.
The virtues of TopOption:
- User-friendly interface;
- Clear information about licensing;
- Low minimum not to be expected
The drawbacks of TopOption:
- Absence of the Russian regulator’s license;
- A confusing website with poor quality information.
After choosing a broker, it is necessary to pay special attention to the trading strategy. There are several dozen different binary options trading strategies offered by brokers and option trading gurus. They all promise fabulous profits with minimal investment. You should not rely on such loud assurances and you should analyze possible behavior models when performing operations with binary options yourself.
Let’s start with the simplest thing – mathematics, and more specifically with the so-called mathematical expectation, i.e. the average value of profit that a trader can get. Let’s assume that the value of the option is $100, with a profit of 70%. Suppose a trader opens a position in the right direction and makes a profit. Now his balance is $170. The trader again acquires an option for 100 dollars, but this time the market goes against him, and from 170 dollars remains only 70 dollars. When the situation repeats itself, the balance will gradually melt. There is a negative mathematical expectation, which puts the trader at a disadvantage in advance.
Thus, the main principle of the trading strategy should be the minimum loss ratio of transactions with a constant amount of investment. A thorough technical analysis using ultra-short term options (a few minutes) can help to achieve this. Fundamental analysis will only work on longer periods (from 1 week).
You can analyze other brokers offering binary options in the “Binary Options Brokers” section.