How Binary Options Work

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Are Binary Options Right For You?

Binary Options Offer All or Nothing Risk

If you're not that familiar with binary options its probably because they are a relatively new type of investment product. While stocks, bonds and stock options have been around for hundreds of years, binary stock options only hit the public markets in 2008. Since that time, however, they have grown in popularity and have thousands of traders using them as forms of investment and speculation. Here is a summary of what binary options are and how you can use them.

You've probably heard the term binary before. It is used especially in computer classes to describe bits. A bit is binary, as in it can only have 2 values - zero or one. Binary options are similar. They are a specific type of option. Whereas a typical option pays off based on the ending value of the underlying security or asset, a binary option pays off either 100% or zero percent, depending on whether the underlying asset or security meets the binary option's strike price. For example, if you purchase a binary option on Apple computer that pays off if the stock price is above $500, the binary option will be worth either the face value of the option or zero when the option expires, depending on whether Apple's stock price is above or below the $500 strike price. Of course you can perform this transaction through an online trade. Now,let's look at why this is useful and how you could use it to make money or hedge your portfolio of investments.

Like other options, binary options can be used to either speculate or to hedge your other investments. If you buy a binary option (without owning the underlying asset), you are more or less speculating that the asset price will fall in the options' payoff range at expiration. The risk for this type of investment is so great (all or nothing) that this is known as speculating. Almost like gambling.

You can also use binary options to hedge your assets or investments. By purchasing or call or put option on a security or asset that you already own, you can hedge the risk of owning that underlying asset. For example, if you own Apple stock and it just broke through a new high, you don't want to sell it, but you are worried about the stock price falling in the short term, you could use a binary option to mitigate the risk. You could buy a put option on Apple stock that would pay off if the stock price fell. That way, if the stock falls you will get a return on your option that will offset some or all of the loss on your stock position. The advantage is that you didn't have to sell your Apple stock and pay the taxes.

These examples were rather simplified, but hopefully they give you an understanding of binary options and how you can profit from them, and whether they may be worth pursuing for your investment needs.