What Are Binary Options and How to Trade?

The simplicity of binary options is appealing because there’s a fixed payout and a fixed risk, which is known at the outset of the trade. Keep reading to learn all the key things you need to know about trading binary options: terminology, what assets you can trade with binary options, how to find a broker, when to trade, strategies, and more.

How Binary Options Work

The most common type of binary option is a high/low option. You can buy a “put” or a “call.” Let’s explore in-depth how trading binary options works.

If you think the price will be above the strike price at expiration, you would buy a call. If you think the price will be below the strike price at expiration, you would buy a put. Every binary option has an expiration; at expiration you find out if you made or lost money, depending on whether the asset’s price landed above or below the strike price.

The strike price is usually the current price of the asset when you place the trade. For example, if the price of the EURUSD is 1.0550, and you buy a put option with an expiration of one minute, in one minute the price needs to be below 1.0550 for you to make money. If the price is above 1.0550 when the option expires, you lose the amount you bet.

You decide how much you want to bet on each call or put. You could bet $10 or $10,000. Each broker has a minimum and maximum bet size. How much you can win and lose is known before the trade. If you lose, you lose the amount you bet, or 100% of the bet size. If you win, you receive a payout, which will be posted by the broker when you make the trade.

The payout amount typically ranges between 70% and 90% of the bet size. For example, if you bought a $100 call option on the EURUSD at 1.0550 with a 85% payout, and one minute later the EURUSD is trading at 1.0555, then you win $85. You also receive your initial $100 back.This is called being in the money (ITM) because the price is above the call’s strike price.

If the price is trading at 1.0547 after the one-minute expiration, you lose $100. This is called being out of the money (OTM) because the price is below the call’s strike price. Here are the key terms to remember:

• Underlying Asset: The price movement of the asset you are betting on with the binary option. When trading a binary option, the underlying is never owned, it is simply a bet on the underlying price movement
• Call: Bet on the underlying price going up.
• Put: Bet on the underlying price going down.
• Strike Price: The level which determines if your option is profitable or not.
• Expiration: When the option expires, and you get to see if you won or lost.
• In the Money (ITM): The underlying asset’s price is above the strike price for a call. The asset’s price is below the strike price for a put.
• Out of the Money (OTM):The underlying price is below the strike price for a call. The asset’s price is above the strike price for a put.

Types of Binary Options

The most common binary option type is the high/low, discussed above. But there are other types of binary options which are beneficial for other strategies.

Here are the other types of binary options and how they work:

• High/low Binary Options: You receive the defined payout if the option expires in the money, and lose the amount bet if the option expires out of the money. This is the most common type of binary option. Payouts are between 70-90%.
• One-Touch Binary Options: This type of binary option typically has a higher payout, potentially exceeding 100%. A once-touch means the underlying price has to reach a specified strike price before expiry. If it does, you receive the payout.

If it doesn’t, you lose the amount you bet. The further away the strike price, the higher the payout. Trade this type of option if you are expecting a big underlying price.

• No-touch Binary Options: A no-touch means the underlying price can not reach or move through the strike price before expiry. If the underlying price doesn’t touch the strike price(s), then you receive the predetermined payout. If the underlying price does touch or move through the strike price, you lose the amount you wagered.
• Ladder Binary Options: This is a less common type of binary option. There are a series of strike prices that the underlying price has to be above (call) or below (put) at expiry. Each strike price, or rung of the ladder, has its own payout.

If you think the price will rise, for example, over the next hour, you could buy a ladder call with three consecutively higher strike prices. For each rung the underlying price is above at expiry you receive a payout, such as 25% for the first rung, 40% for the second rung, and 55% for the third rung.

Which Assets to Trade with Binary Options

Many commonly traded financial assets can be traded through a binary option.

Binary options typically trade on highly liquid assets that are actively traded. For example, you can trade binary options on stocks indices or stock index futures contracts. Heavily-traded forex pairs and commodities are also common. Some binary options brokers also offer options on crypto currencies such as Ethereum and Bitcoin.

Binary options are available on some popular stocks, like Apple (AAPL) or TSLA (TSLA), but you won’t find binaries on stocks that aren’t well-known. Stocks, stock indices, commodities, and forex are the main underlying markets for binary options.

You probably won’t see binary options based on bonds, art, or other collectables. Every binary options broker varies slightly in terms of the underlying assets they offer options on.

How to Trade Binary Options

Here areomethings to consider when getting set up to trade binary options, and also once you actually start placing trades. Every step is important.

Get Set Up With a Binary Options Broker

I’ll discuss choosing a broker a little later on. But for now, just know to choose a broker that offers a demo account so you can test out how they work and practice trading without risking real capital.

Choose Your Underlying Asset

Pick an underlying asset you are interested in. Maybe it is gold, or the S&P 500 stock index, or the EURUSD. Success is more likely if you start out by focusing on one asset and studying how it moves and what affects its price movements.

Avoid the temptation to trade too many things at once. Different markets may move differently and be affected by different factors. Instead, zero in and specialize. One market isn’t better than another, so pick the one you’re most interested in.

“It’s not what we do once in a while that shapes our lives. It’s what we do consistently.” – Anthony Robbins

Consider Market Direction

Making money on binary options requires getting the direction of the underlying asset right. For short-term options that expire within minutes, hours, or even days, look at whether the price has been trending up or down.

You may wish to include some technical indicators in your analysis, such as whether the price is above or below a moving average (which helps determine the trend) or if the MACD or RSI is reversing. For longer-term options which last weeks, consider what fundamentals factors are driving the price. Interest rates and economic health are examples of this.

For example, if the USA is aggressively raising interest rates faster than other countries, and that is expected to continue, that could increase the price of the US dollar. Developing strategies for determining market direction takes time, so choose a few tools and stick with them. Just like picking an asset to trade, specializing will generally result in a quicker path to profitability.

Trying to learn every technical analysis tool is a waste of time, so focus on a few technical tools you are interested in, and then determine how they can help you determine market direction.

“Risk comes from not knowing what you’re doing” – Warren Buffett

Consider Expiration Time

With a binary option, picking the direction is the only thing to consider. To make money on a call the underlying price needs to be above the strike price at expiration. To make money with a put the underlying price needs to be below the strike price.

If you get the direction right (before or after expiry), but the underlying price is on the wrong side of the strike at expiry, that will still result in a loss. When conducting your directional analysis, also consider when you think the price will rise or fall, and how long it will stay there before reversing or pulling back. Set an expiration that accommodates this.

Strategy Examples

There are different strategies for determining market direction and expiration times. Here are some examples. Read the linked articles to get an in-depth overview of how each strategy can help you make money.

• Scallop Strategy – a pattern that points to the next price direction.
• Cup and Handle Strategy – a price pattern which often leads to an explosive price move.
• Rising or Falling Wedge Strategy – another pattern that leads to strong price moves when the pattern is broken.
• Strangle and Straddle Binary Options Strategy – Useful when a large price is expected, possibly due to the news, but the direction of the move is unknown.
• Head and Shoulders Strategy – A pattern for spotting trend reversals.
• Scalping Options – a method for making big percentage gains quickly.

The Trading.biz blog is regularly updated with new strategy ideas.

Binary Options Risk Management

It doesn’t matter if you make a lot of money if you end up losing even more. Risk management controls our losses so we can stay ahead. I use two forms of risk management: trade risk management and daily risk limit.

For trade risk, bet a maximum of 2% of your account per trade – 1% or less is even better. For example, if you have a $10,000 account, bet $100 or less on each binary trade. This way, if you lose, you have only lost 1% of your account. Even a string of losses won’t draw down the account much.

If you have a $10,000 account and risk $500 per trade, several losses in a row could see a large chunk of your capital wiped out. Now with less capital, it will take longer to claw back the losses and get back into profit. Control risk on every trade by controlling how much you bet on each trade.

For daily risk, control how much you can lose in a day. For example, set a maximum loss of 3% of the account per day. If risking 1% per trade, this means you would need to lose three trades without any winners. If risking 0.5%, you could lose up to six trades and still only be down 3%.

The daily risk limit avoids one bad day ruining our week, month, or entire account. Many traders enter a downward spiral when they start losing. They trade more frequently, abandon their strategy, and trade impulsively. This leads to even bigger losses. Avoid this by setting a daily risk limit for yourself. If you hit it, stop trading. There’s always another day to trade.

“Where you want to be is always in control, never wishing, always trading, and always, first and foremost protecting your butt.” – Paul Tudor Jones

Binary Options Brokers and Regulation

Most binary brokers are not regulated, and binary brokers outside the US are not allowed to solicit customers from within the US. There are binary brokers outside the US that are regulated in jurisdictions that allow binary options trading.

When a broker is regulated, it means they are subject to oversight by a government appointed organization. The broker is more likely to be reputable and operating within the confines of law. Regulation, however, doesn’t assure the company will be ethical.

There can be issues with both regulated and unregulated brokers, but issues are more likely to arise with unregulated brokers. Regulated brokers must undergo financial inspection, hold an application process, and operate in accordance with local laws.

If an unregulated broker has been around for many years, and has good customer reviews, it may be a viable broker. That said, how the unregulated broker operates is at their own discretion and not subject to any oversight. This can present an additional risk to you as a trader.

When possible, choose a regulated broker with good reviews. See our full guide on binary options brokers to help you choose.

Pros and Cons of Binary Options Versus Traditional Trading

In the stock, forex, or futures markets, you own the underlying asset; however, with binary options, you never own or have control of the underlying asset you’re trading.

But even beyond this, trading binary options and traditional markets are quite different. Let’s look at a few of those key differences. With binary options you have a fixed risk and a fixed profit. This is known at the outset of the trade.

With stocks, forex, or futures you can cap your risk yourself, but there is the possibility that you could lose more than anticipated. If you plan to get out of a stock if it drops 5%, but the company comes out with bad news overnight and the stock drops 50%, well, you are suddenly facing a much bigger loss than expected.

With binary options, you can only lose the amount you bet on the trade. The flip side of this is that binary options cap the upside, whereas traditional markets don’t. Binary options typically pay out a portion of what you risk, but in traditional markets, you could risk $1000 and exit for a $4000 profit. The binary option pays you out 70% to 90% of the amount risked, so in this case it would be $700 to $900.

Binary options are simple financial products. You don’t need to worry about stop losses, profit targets, or trailing stop losses like you do in traditional markets. Binary trades have a fixed time frame, and you are right or wrong. There is little discretion involved once the trade is placed.

High/low binary options generally offer a negative reward vs. risk. You lose 100% of your bet if you lose, but you make 70%-90% if you win. This means you need to be right on at least 60% of trades you take.

In traditional markets, you can risk 1% of the account and get out when you are up 3% or 4% on the account. This is a positive reward vs. risk. It means you only need to be right 40% of the time to make money over many trades. Both markets may be viable depending on what you are looking for, but realize that with binary options you will need to be right more than 60% of the time to make money.

NADEX Binary Options

NADEX stands for the North American Derivatives Exchange, which is licensed to offer binary options to traders in the US. NADEX binary options trade differently than binary options outside the US (discussed above).

Here’s a quick intro to NADEX binary options. NADEX binary options are valued between 0 and 100, which for each contract, equates to $0 and $100. NADEX has set strike prices, unlike other binary options brokers where the high/low option strike price is usually the current price. If the NADEX option is trading near the strike price, it will have a value near 50 or $50.

This means that if you buy this option, and it expires in the money, you make $50 ($100 at expiry less the $50 you paid). If the option expires out of the money, you lose $50 ($0 at expiry and you spent $50 on it). If the option is well into the money and near expiry it will trade near 100. If it is well out of the money and near expiry it will trade near 0.

Essentially, the more likely the option will close in the money, the closer it will trade to 100. The more likely the option will close out of the money, the closer will trade to 0. At expiry it will be worth either 0 or 100. If you bought an option at 20 and it expires at 100, you make $80. If you buy it at 70 and it expires at 100, you make $30. If you buy at 40 and it expires at 0, you lose $40.

The most you can lose is $100, and the most you can make is $100 per contract. Gains and losses will generally be smaller than this since the purchase price of the option is somewhere between 0 and 100. NADEX charges $1 per contract to close trades before expiry, and $1 per contract that expires in the money. There is no fee on options that expire out of the money.

Binary Options Scams and How to Avoid them

There is always a financial scam going on somewhere; it’s not limited to binary options. Here are some tips to avoid getting scammed by brokers and marketers.

Here are some of the most common types of scams to look out for, along with steps you can take to avoid becoming a victim.

• The broker takes off with your money. This usually happens with unestablished brokers. Basically someone set up a website, made it look legitimate, got your money (and others), and is now running off with it.To avoid this, only trade with brokers that have been around at least a few years and that have a well-established reputation and lots of reviews.
• The broker offers you a deposit bonus and then uses it against you. This isn’t actually a scam, it is more of a “fine-print” issue. They give you a bonus, but when you go to withdraw funds, they don’t let you because some of the money in your account is theirs.I don’t take deposit bonuses, and if I do, I read the fine-print before accepting. Always know what you are signing up for.
• The broker manipulates prices or orders. This is outright fraud when the broker manipulates prices to make it look like you lost (when you won) or they don’t let you place orders when you want.Once again, stick with well-established and regulated brokers. A broker won’t get away with fraudulent activity for long without people talking and venting about it online.
• The broker looks legitimate, but isn’t. Above, I mentioned trading with a regulated broker – but just because the broker’s website says they are regulated doesn’t mean they are.Brokers specify who regulates them. Go to the regulator’s website and look up the broker in question.

If they are listed as regulated, that’s great. If they aren’t regulated by who they say they are, the broker is lying and you may want to alert that regulator…and don’t trade with or send money to that broker.