There are several trade options or trade strategies offered by the binary options brokers on their trading interfaces. Some are meant to be used by both novice and experienced traders while some are meant only for experienced traders. The more advanced a trade option becomes, the riskier it gets but it also gets enormous amounts of flexibility in terms of selecting the parameters of trade which include the strike price and the expiry time. In this section we will go through the basic trade strategy in details while briefly explaining the rest and we shall get involved into more detailed explanations of the other trade options in Lesson Three. So, let us begin!
Binary Options: This is THE MOST basic form of trading which can be used by anyone and everyone. There are certain limitations to this trade option in terms of predefined contract which will not allow the traders to select the strike price and the expiry time as per their comfort. They will also not be allowed to select the amount of money they want to invest but will rather have to select an investment amount from a set of predefined amounts as provided by the broker.
The basic idea behind this trade form is to determine whether the price of the underlying asset being traded will increase above the strike price or fall below the strike price within a specified time frame or not. If the prediction turns out to be true, the trader will earn some profit, the percentage of which is also defined by the broker in the trade contract, or the trader will lose money as defined by the trade contract. We will get a thorough knowledge of this trade option with help of an example. We will make a few basic assumptions for the purpose.
- A trader enters the market at 10.00 AM in the morning and decides to trade in stocks and decides to work with a single company. He or she selects the company called XYZ.
- The trader finds that the stock of XYZ Company is trading at a price of $10 per unit when the trader entered the market.
- The trader conducts a quick analysis of the market and speculates any one of the following outcomes: (a) in next 5 minutes the price for per unit of stock for XYZ Company will increase and finish above the current price of $10 at which it is currently trading or (b) in next 5 minutes the price for per unit of stock for XYZ Company will decrease and finish below the current price of $10 at which it is currently trading. For first speculation the trader will decide to buy a Call Option and for the second speculation, the trader will decide to buy a Put Option.
[Reminder: Call Option is purchased only when a trader thinks that the price of the underlying asset will move up and Put Option is purchased only when a trader thinks that the price of the underlying asset will move down. Both Call and Put Options are capable of generating profits in case of correct prediction and both can lead to losses in case of incorrect prediction. Only one type of Option can be bought at a time for a particular underlying asset.]
Situation 1: The trader decides to go for a Call Option. In other words, he or she thinks that the price of the stock of XYZ Company will increase in next 5 minutes. This is what he or she does now:
- The trader clicks on the Call button. Once the trader clicks the Call button, he or she agrees on a predefined profit and loss payout as mentioned by the broker. We assume that if the trader wins, the broker will bay 80% profit on investment and if the trader loses the trade, he or she will have all the investment amount forfeited by the broker. That is the return will be 0% and the loss will be 100%.
- The trader will select the time frame for the trade and put it as 5 minutes on the trading interface. This ‘5 minutes’ becomes the expiry period of the trade.
- The trader will select the investment amount for purchasing the Call option. Brokers generally allow $10 minimum investment and up to $1,000 maximum investment per trade. However, these values can differ from one broker to another. For the time being let us assume that the minimum investment allowed is $10 and hence, the trader selects $10 as the investment.
- The trader will now click on the Start button.
When the trader clicks on the Start button, the following things happen:
- The current market price of the stock of XYZ Company, i.e. $10 becomes the strike price. This will be the base price with respect to which the stock will be trading. For the trader to win the Call option, the price of the stock of XYZ Company will have to be greater than $10 after 5 minutes of trading.
- The moment the trader clicks the Start button the trade starts. Let us assume that the trader clicked on the Start button at 10:01 AM. So, the trading beings at 10:01 AM and will continue for 5 minutes choses as expiry time selected by the trader. The trade will then automatically close at 10:06 AM.
During this 5 minutes of trading, the only think the trader needs to do is to sit and wait for the trade to expire. After 5 minutes of trading when the trade closes automatically, the results will show on the screen of the trading platform. If the stock of the XYZ Company ends at $10.20 (just an assumption), the trader will win. So, according to the trade contract, the broker will now have to pay profits to the trader. As per the contract, the trader will get 80% of the investment amount as profit. In our example, the trader invested the minimum allowed, i.e. $10. Hence, the profit he earns out of the winning trade is 80% of $10, which is $8. So, the broker will pay back the trader an amount of $18 ($10 investment made by the trader + $8 profit earned by the trader).
On the other hand, if at 10:06 AM, the stock of XYZ Company ends at anything below $10 strike price, the trader loses. Let us assume that the price of the stock of XYZ Company ends at $9.90 at 10:06 AM, the trader loses the trade and as per the trade contract, the broker will forfeit the investment amount. So, in this example, if the trader loses, he or she loses $10.
Note: At the end of the trade, the price of the trading asset will have to be above the strike price for the trader to win the trade. The trader will not be concerned about the percentage or magnitude of price increase. The only thing that matters is that the price has to be above the strike price after the trade expires.
Situation 2: The trader decides to go for a Put option. Everything described above in the example remains the same except that this time the price of the stock of XYZ Company has to fall and reach under the strike price of $10 at the end of the trading period. In other words, when the trade expires, the price of the stock has to be below $10. By what percentage or what magnitude the price falls is not relevant. What matters is that the price must fall. If somehow the price of the stock ends above the strike price of $10, the trader will lose the trade.
Not all brokers will be same: The funny thing about trading in binary options is that you will get confused at the beginning not because the trading is very complicated but because there are different names for the same concept. It is something like someone calling you by your good name and someone else calling you by your nickname! Eventually, both people will be calling you. This is where you memorize the different names used by different brokers for the same thing. The quick list is mentioned below:
- “Binary Options” – This is THE MOST basic form of options trading strategy. Some prefer to call it “Digital Options” while some will call it “All-or-Nothing Options”. Yet others will call it “Fixed Return Options” while someone else may prefer calling it as “Classic Options”. The last name – “Classic Options” is not much in use.
- “Pro Trader” – This is a slightly advanced form of options trading strategy but different brokers will name it differently. Some will call it “Pro Platform”, some will prefer “Binary Meta” and some will like the name “Open Platform” and some will call it “Option Pro”. We will quickly learn about this trade option in a while but we will go for a detailed explanation in Lesson Three.
- “Call and Put Options” – “Call” refers to the speculation of asset prices moving up while “Put” refers to speculation of asset prices moving down. Some will prefer calling these as “Up and Down Options”. Some will call it “High and Low Options”. Someone else will call it “Above and Below Options” and yet again, someone else will call it “Over and Under Options”. You just need to remember that ‘Call, Up, High, Above and Over’ – all refer to the speculation of asset prices moving up while ‘Put, Down, Low, Below and Under’ – all refer to the speculation of asset prices moving down.
- “Strike Price” – This is the price of the asset at the point of time when you start trading. This is the technical term generally used by almost all brokers but you may come across certain brokers who prefer calling it “Current Price, Market Price, Prevailing Price, Existing Price or Entry Price”. These variants are however not in frequent use but it is always good to know.
So, what we see here is that it is the naming structure that can differentiate one broker from another but that’s not all. There will be some other major differences in terms of offerings. We will go through these quickly:
- Different brokers will have different payout percentages. Some will offer up to 90% profits for winning trades. Some will offer up to (i.e. maximum) 85% profits while still others may offer up to 75% profits for winning trades. Why this difference? This depends on the operating expenses of the brokers, the restrictions put by the regulatory bodies where they operate, the size of the broker and other factors. You really cannot go about negotiating the profit returns with one broker based on what others are offering. You will not be entertained. It as simple as this – “You agree or you don’t – no arguments!”
- There is a trade option called One Touch (we will learn about this shortly) where some broker will offer up to 500% returns on winning trades while someone else will offer up to 400% returns. The reasons are the same as mentioned above.
- The minimum amount of trade allowed for each trade in any trade option may also vary from one broker to another. Some will allow a minimum of $10 while some will allow a minimum of $25. This is primarily because of the money management expense which essentially boils down to operating expenses of the broker.
- The loss percentage will also vary among the brokers. Some brokers will simple forfeit 100% of the investment amount and offer 0% return for all losing trades in all trade options or trading strategies. Some will offer 0-10% refund on investment for losing trades in different trade options or trading strategies. This is also driven by factors like operating expenses and size of the broker in terms of client base, liquidity etc. While other may just be driven by the motive of attracting new traders and retaining existing traders.
The bottom line is that no two brokers will be identical. So, broker selection will be a crucial factor and you must weigh the advantages and disadvantages of each one of them before registering with any one of them.
One Touch: This trade option is almost similar to the basic strategy called Binary Options. The only difference is that in Binary Options traders were not required to predict the magnitude of price change but here in One Touch, traders will have to predict the magnitude of the price change. For a trade to a successful, the price of the underlying asset has to TOUCH the predicted price at least once during before the trade expires. If the strike price touches the predicted price at least once before the trade expires, the trader wins and if the strike price fails to touch the predicted price even for once before the trade expires, the trader loses the trade. One Touch trading generally has a longer expiry period, which is generally a week or it can be even greater. One Touch options can be used only during the weekends. The rate of return is also significantly higher in case of successful One Touch trades. We will explain this strategy in greater details in Lesson Three.
Option Builder: This form of trade option or trading strategy is designed for those who want greater control of their trades. In other words, it is basically for experienced traders who have a very good understanding of the market and like to decide the amount of risk they want to take and the amount of insurance they want to protect their invested amount should the speculation turns out to be incorrect. Here the traders do not go by the standardized or predefined expiry time frames or risk levels. The trader control the risk they want by determining the amount they want to invest, the return the want for winning trades and the security they want for losing trades. They also determine the expiry time. This form of trade option is suitable for those who have their individual trading styles and prefer to stick with their understanding and analysis of the market. We will explain this in Lesson Three with examples.
60 Seconds: There is hardly anything to explain here. If you have understood how the basic Binary Options strategy works, they you already know how to trade with 60 Seconds strategy. In the classic version, the expiry time could be 5 minutes, 15 minutes or greater. In 60 Seconds, everything remains the same except that the expiry time is now reduced to merely 60 seconds or 1 minute. This is the fastest form of options trading and is designed for those who don’t love to wait for long to get returns. We will still explain this in greater details in the next chapter.
Pro Trader: This is again very much like the basic Binary Options trading strategy with only a few extras. Here the traders get a more polished graphical interface that allows the traders to trade the past price movements of the selected asset. This helps in better analysis and hence, relatively more accurate trading. In addition to this, the trades also have the option of doubling their profits by doubling their investments or minimize their risks by closing their trades ahead of time any time before the trade expires.
Ladder Trading: If you are not an experienced trader, you are advised to steer clear of this trade option or trading strategy. It is for those who have a very good understanding of the market and make very good speculations about the market movements and have a knack of taking risks. The name is literally derived from a ladder. The trade is much like building up rungs of the ladder. The traders are required to predict three different prices with respect to the strike price and will have to use three different expiry time. This allows the traders to partially win the trades. For instance, if the first speculation is incorrect and the remaining two are correct, the trader wins two parts of the trade. It may happen that the trader makes all three speculations correctly. This will maximize the profits. It may also happen that all three predictions turn out to be incorrect and can lead to total loss. In-depth understanding of the market is very essential to use trading strategy as it can lead to enormous losses. We will learn more about this trading strategy with examples in the next lesson.
Dynamic Touch Trading: This is a relatively new trade option but is very similar to the One Touch option we briefly described above. The traders can actually trade daily with the dynamic touch trading. They can select the asset they want to trade in and they can also select the expiry time from list of available expiry times. Unlike the One Touch option where the traders are allowed to predict the touch level or the price of the asset, in case of dynamic touch trading, the broker determines the level that the strike price must touch. This strategy allows both touch and no touch options. In touch option, the strike price will have to touch a certain price level within the expiry time and in no touch option, the strike price should never touch a certain price level within the expiry time.