One of the big benefits of trading traditional binary options is the simplicity, and the ease with which risk can be managed. Binary options are, by definition, all or nothing. But as brokers innovate with trading tools that allow, among other things, doubling up investments or cashing in trades early, are the lines becoming blurred?
Particularly for novice investors, the idea of knowing exactly how much money is at risk at the outset of a trade is reassuring. This is what has allowed binary options to grow so rapidly. High returns are another obvious draw, but the simplicity is a key attraction. As these traders begin to use additional features, for example cashing in a trade early – either to take a profit, or minimise losses – does this ease the way for discovering the merits of trading binaries via an exchange instead?
The Standard Model
With a traditional binary option, a trader can expect one of two outcomes. Either a trade finishes ‘in the money’ and returns a profit. Or the trade finished ‘out of the money’ and all of the initial investment is lost. With an exchange, the trade will ‘settle’ with a value of either ‘0’ or ‘100’. ‘0’ represents an event that did not happen, ‘100’ something that did happen. So, as an example, if the option taken was ‘Will asset x finish higher than 150 at 16:00?’, and the price was 148 at 16:00, the trade would settle at ‘0’. If the close price had been 155, the trade settles at ‘100’.
The outcome remains ‘binary’. The end result will be either ‘0’ or ‘100’. The real benefit of an exchange however, is that the value can be traded up until the expiry time. In the above example, assume that the asset price was 148 at 15:45. There are 15 minutes until the trade closes – and the current value is below the option price of 150. So traders might be confronted with a trading spread of something like: 44-46 (44 to sell, 46 to buy).
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In this instance, a trader expecting the price to finish above 150 would ‘buy’ at 46. If they were ultimately correct, the market would settle at 100. The trader would make 54 times the per pip value. If the market moved against the trader, he would lose 46 times the pip value, as the market would settle at ‘0’. The additional problem for traders here, is calculating what 46 times the pip value is, and therefore the financial exposure they face. They may also however, include a stop loss to minimise losses and control risk further.
Complexity vs Flexibility
It is clear then, that trading a binary option via an exchange adds a layer of complexity. Not a huge amount, but certainly more than the black and white situation of a traditional option. But is the added complexity worth it?
Exchanges offer some significant benefits. Firstly, the spread is generally very tight. This makes the trades very attractive when compared to a traditional option payout. The real benefit however, is the ability to ‘trade’ the option. While some brokers do allow binary options to be ‘cashed in’, a genuine exchange offers far more flexibility.
Continuing the example above, our trader places a buy order at 46. Within 5 minutes, the asset price has moved up to 153. The spread has moved accordingly. With 10 minutes left until expiry, and the price above the target of 150, the spread might now be 63-65. Our trader could sell the option at 63 – collecting 17 pips. The profit is locked in, regardless of what happens to the price in those closing 10 minutes. Again, the tight spreads mean that trading in and out is viable – a traditional binary options broker is taking a much larger chunk of value at each trade – eroding the profits of any trader moving in and out of a trade.
So using binary options over an exchange really comes into its own when a trader prefers the use of longer term expiry times, and is also keen to trade the positions, rather than merely letting them run until expiry. The same trader might exit a trade that has moved against them in exactly the same way, and reduce potential losses. Being able to trade via an exchange is an extra tool that most binary traders will want in their armoury, and is well worth investigating.