A binary option is a kind of a financial option which is based on a ‘yes’ or ‘no’ question. It is a financial instrument in which the buyer receives a payoff or loses the entire investment, depending on whether the option expires according to the buyer’s prediction. Since this financial instrument is based on a simple ‘yes’ or ‘no’ proposition, i.e. involving two outcomes, it is known as ‘binary’ option.
In a binary options trade, if there is a gain or loss, it is automatically credited or debited to the buyer’s or seller’s account upon expiry of the option. Binary options can be traded based on the prices of assets like gold, silver, stock of a company, bitcoin binary, etc.
Basic Working Principle of Binary Options
To put it simply, in binary options, there can be a fixed amount of payoff or nothing at all. The question put forth right before trading on a binary option is whether a particular asset or event will be above or below a particular price (referred to as strike price) in the underlying market at a particular time.
If the trader thinks that the price will be above the strike price he will buy the option, otherwise, sell it. If at the expiration time, the price is above the strike price, the buyer will gain a payoff and the seller will suffer a loss and vice versa. The working principle is the same for fiat money as well as for crypto currencies (such as bitcoin binary options).
Example of How Binary Options Work
Suppose a binary option is whether the share price of XYZ will be above $30 on September 24, 2019, at 11.30 a.m. Here, the strike price of the share’s binary option is, therefore, $30. The trader has to make a decision, whether yes (i.e. it will be above $30) or no (i.e. it will be below $30). If yes, he buys a binary option. Let’s say the price of the binary option is $100 (the price of a binary option ranges from $0 to $100).
If at that date and time, the share price of XYZ is noted as $36 (i.e. above the strike price), he will get a payoff as per the terms agreed with the broker. For example, if the payout was 75%, the broker will credit $75 to his account. On the other hand, if the share price of XYZ trades below $30 at that date and time, he will lose the $100 investment that he had made in buying the binary option.