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What is a Binary Option?

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  • Written By: Daniel Khalil
  • Edited By: C. Wilborn
  • Last Modified Date: 21 September 2016
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A binary option is an investment vehicle with only two outcomes — either the investor will be paid a certain amount if the option reaches a certain level, or nothing if it does not. Unlike a regular option, which gives the investor the right to buy or sell an asset at a certain price, a binary option is like a wager that the asset will reach a certain price on a certain date. If the asset reaches this price on the strike date, the investor is paid the amount specified in the option contract; if it does not, the investor gets nothing. Stock market trading like this is uncommon, but many people make large sums of income via this type of investing.

There are two main types of binary options: cash-or-nothing and asset-or-nothing. In a cash-or-nothing binary option, an investor will receive a fixed amount of cash if the asset — often a stock — reaches the strike price. An asset-or-nothing binary option payoff is equal to the value of the asset price. When the asset reaches the strike price, it's called being "in the money."

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If an investor purchases cash-or-nothing binary call options of Company A, for example, with a strike price of $25 US Dollars (USD) and a pay out of $400 USD, he would get the cash if the asset is at or above $25 USD on the strike date. If Company A's value fails to reach that $25 USD benchmark, however, also known as being "out of the money," then he gets nothing. In some cases, the investor will be able to recover up to 5% of the "investment," but usually he forfeits all related assets when he loses a binary option contract.

A binary option is often called an "all-or-nothing option" because the investor either gets the full amount or nothing at all. There are also other ways in which to use a binary option in the market. Some contracts will, instead of a payout, permit the interested party to purchase assets for a reduced price. These can be quite profitable to sell to others willing to pay the much higher market price.

The binary option could be a foolish investor's worst nightmare, leaving him empty-handed if the asset doesn't reach the expected price. If, however, the market turns in the investor's favor, then he will often be well rewarded. Binary options can usually be resold at a markup before the strike date, removing some of the pressure of this type of exotic option.

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