Explore Your Options by Tom Gentile
BINARY OPTIONS: TO TRADE OR NOT TO TRADE?
I got a question the other day that had to do with a recent product called binary options — what they are, and if they were worth trading. Can you tell me?
A binary option, much like placing a bet, is basically an all-or-nothing option, meaning you either make a predetermined payout or asset if you are right or you get nothing if you are wrong. Binary options fall into one of two categories: all-or-nothing cash binaries, or all-or-nothing asset binaries. Each of these categories has both call and put options. So when choosing a binary option to trade, you must first ask yourself, “Do I want my payout in cash or in the asset?” From there, you determine the type of option.
Say you think that Apple, Inc. (AAPL), will close at or above $700 by the close of trading (Figure 1). You want to trade a binary option on AAPL where if the stock trades at or above $700 a share, you receive a $100 payout per contract. You decide to buy a call option on AAPL closing at or above $700 at 4:00 pm at a cost of $50 for the contract. What’s the risk and reward for this binary option trade?