Here in Chapter 2, our primary objective will be to learn the technical terms that are used in binary options trading. Unless you are aware of these terminologies and unless you have clear understanding of the terms, you cannot trade with confidence and this can lead to bad starts leading to loses! We will also take a tour of the trading interface where you will actually execute all your trades and we will learn about the different trading strategies available with all major brokers in market. We will also learn about when to trade and what to trade to make sure that you do not make any incorrect decisions while trading. But again, the accuracy of the decisions you make will depend on how well you understand the concepts and how well you speculate the market movements through your analysis of market news. At the end of this course, you will be prepared to enter the real trading market and you will be equipped with all basic tools you will need to start with. Definitely Chapter 2 will not cover advanced training courses and hence, if your ultimately objective is to become an advanced trader, you will have to go through all lessons. Remember that Rome was not built in one day. You cannot become an expert trader just after one lesson or two!
Trading Contract – What Is It?
A trading contract in terms of binary options trading refers to an agreement between the trader and the broker. The agreement will consist of several predefined set of conditions and this conditions cannot be changed neither before trade, nor during trade and not even after trade. These conditions specify certain aspects of trading in a particular asset class or underlying asset. The agreement will define the values of certain parameters that the trader must accept before starting a trade. The agreement will generally contain the following:
Strike Price – This refers to the current market price of the underlying asset to be traded. Strike price will refer to the price of the asset at the time when the trader enter the market and starts trading. For instance, if the trader enters the market at 10 AM EST, the price of a particular stock may be $10 per unit. The same stock can have a strike price of $12 if the trader enters the market at 1 PM EST. When the trader enters the market at 1 PM at the prevailing stock price of $12, he or she cannot ask for the strike price that was present at 10 AM. The trader will have to accept the strike price of $12 at 1 PM. At any point in time, the strike price is fixed depending on what the market offers and the trader will agree to buy call or put options at the prevailing strike price.
Movement – Movement refers to the price movement or market movement. Even the broker has no control over this price movement as it is determined by numerous factors that directly or indirectly affect the price and some factors can be beyond human control like natural perils, war etc. The traders will have to acknowledge and accept the direction in which the price movements take place. For instance, if the trader predicts or speculates that the price for a particular stock will move up during the trading period and buys a Call option but finds out that price decreases, the trader will not have the liberty to cancel the trade and ask for refunds. Thus, the trader will have to accept the price movements irrespective of the direction of movement.
Time – Any trade can never continue indefinitely. It has to expire or end at some point in time. This is what ‘time’ refers to in a contract. To be more technical, it is called expiry time. The contract will also define a set of expiry times for each trade. Luckily, the trader will have to freedom to select from a predefined set of expiry times for his or her trade. In certain forms of binary options trading, these expiry time choices are defined by the broker and for some other forms of binary options trading, the trader can define his or her own time but the trader will have to define a particular time frame and cannot trade without defining any expiry time. Whatever time the trader defines becomes the part of the contract and cannot be changed later and the trades cannot be extended beyond that time frame.
Investment Amount – In order to be able to trade in binary options market, a trader needs to buy a Call or a Put option and not a real asset. This is called the investment amount. A quick example will be helpful. Let us assume that a trader enters the binary options market and finds that the price of stock that he or she wants to trade in has a strike price of $10. Based on his or her analysis of the market news, the trader speculates that the price of the stock will experience an upward movement in next 15 minutes. So he decides to trade for 15 minutes (this will be the expiry time for the trade after which the trade will no longer be valid) and buy a Call option for $20. This $20 is called the investment amount.
Payout Percentage – Any binary options trading contract will have predetermined payout ratios. These payout percentages are defined by the broker and cannot be negotiated. For instance, a broker may offer 90% payout for a winning trade and 0% payout for a losing trade. The trader will have to accept this. Going by our above example, if the trader’s prediction turns out to be correct and the stock with the strike price of $10 actually experiences an upward movement for next 15 minutes and stays above or at the strike price at the end of 15 minutes but does not fall below the strike price, the trader will win the trade. If that happens, the broker will pay 90% of the investment amount to the trader as profit. So, the trader will actually receive $38 which can be broken into two parts: $20 + $18. $20 is the actual investment made by the trader that he or she gets back and $18 is the profit or the payout he or she earned as per the contract’s defined payout percentage for winning trade. If however, the trader loses the trade, i.e. the price of the stock falls below the strike price at the end of the defined 15 minutes of expiry time, the trader will lose his money as per the contract. In other words, the trader agreed on 0% payout for losing trades and hence, the broker forfeits the $20 invested by the trader to buy the Call option.