Binary options terminology
As you start your adventure in binary options trading, it is essential that you have a solid foundation. This includes understanding the jargon that brokers and other traders use.
This lesson will introduce you to some of the most common terminology that you’ll come across.
There’s no need immediately to memorise every term – that will come gradually. Some might not even make sense straight away, but don’t worry – everything will become clearer as you start to see them applied in context.
Simply make sure you read this lesson through now and refer back to it whenever you’re not 100% sure what a term means. Printing this page off and keeping it to hand might help.
We covered this in Lesson 1 but a recap never hurts. Binary options (also called digital options or all-or-nothing options) are trading contracts in which you predict that one of two possible outcomes will occur. With most binary options you receive a fixed payout if you correctly predict that the price of an underlying asset will meet or exceed a pre-determined level (also known as the strike price). Unlike with other trading instruments, it doesn’t matter with a binary option how far beyond that level the price moves. You don’t receive a bigger or smaller payout depending on the size of price moves - you simply win or lose. The two most common types of binary options are call options (you predict that the price will rise to reach or exceed the strike price at expiration) and put options (you predict that the price will fall to or below the strike price at expiration).
To trade binary options, you first need a broker. This is a company or individual who acts like an agent or middleman, matching up buyers with sellers. As a trader of binary options, you make your contract with the broker. Lesson 2 explains what a broker does in more depth.
Before you start trading, you need to put some money in the trading account you hold with your broker. This money is known as a deposit. Depending on the broker you use, you may need to fund the account with a minimum deposit of anything from $100 to around $500.
This term refers to the item or financial asset that your binary option is concerned with. If, for example, you have bought a binary option that pays out if the price of crude oil hits a certain level, the underlying asset here is crude oil. Other assets that binary options can be written against include currencies (foreign exchange pairs such as USD/GBP or USD/EUR), commodities (physical, natural resources like gold, oil, wheat or cotton), an index (an imaginary portfolio of securities that reflects price changes in a market or part of it, such as the FTSE 100 or Dow Jones) or stocks (shares in a company like BP or Vodafone that are listed on a stock exchange).
Bullish markets and bearish markets
With binary options trading, you are usually trying to predict whether the price of an underlying asset will go up or down to hit a pre-determined level. To do this, you need to form a view on whether the overall market for that asset is bullish (the price is generally rising or in an uptrend) or bearish (the price is falling or in a downtrend). A trader who bets that prices will rise is also called a bull, while a trader who bets that prices will fall is known as a bear.
Put options and call options
Once you have formed a view on whether the price of the underlying asset will rise or fall, you will have a better idea what kind of binary option to buy. A put is a kind of option where you effectively opt to sell the underlying asset because you think its value will fall before the binary option expires. With a call, you predict the value of the binary option’s underlying asset will rise before expiry and are therefore opting to theoretically buy that asset. With each type of binary, you receive a payout if your view proves correct.
The current price and the strike price
With binary options, there are two prices you are most concerned with: the underlying asset’s current price and its strike price. The current price (also known as market price) is the actual price of the underlying asset in real time as it trades on the market. Note however that there may be some delay between truly current prices and the ‘current price’ quoted by your broker. In the case of basic up/down or high/low binary options, the strike price (also known as target price or purchase price) is the underlying asset’s current price at the time you enter into the contract. In this case, you win or lose depending on whether or not the underlying asset’s current or market price when the contract expires is higher or lower than this. With touch binary options or range binary options that depend on the price of the underlying asset hitting a certain price before expiry or remaining trapped inside or breaking beyond two price levels, those target price levels are known as the strike price.
You now need to decide a time frame to trade. You may, for example, buy a call because you think the underlying asset’s price will be higher one hour from now. You are not sure however where the price will be in a day’s time. In this case, you should buy a binary option that expires – ie becomes void – in one hour. Binary options come with a variety of expiry times – typically 60 seconds, 15 minutes, 30 minutes, 45 minute, 1 hour, 24 hours or one week.
With some brokers, traders are allowed to close a binary option, causing it to immediately expire.
Not to be confused with the deposit, the investment amount is the amount of money from your trading account that you use to buy an option. Again, the size of this can vary widely depending on the broker you use, the underlying asset you trade on and the kind of option you buy.
In the money and out of the money
These terms refer to whether you have made a profit or a loss on a binary option. A binary option becomes in the money when you make a profit. For example, if you buy an up/high/call option and the market price of the underlying asset rises before expiry, the option is in the money. Similarly, if you buy a down/low/put option and the market price of the underlying asset falls below the strike price or market price at the time you entered the contract, it is again in the money. The term out of the money is used to indicate a loss. If, for example, you buy a put but the price of the underlying asset rises, or you buy a call and the price falls, you are out of the money. Sometimes, a trader makes neither a profit nor a loss on a binary option – for example, if the price of the underlying asset stays exactly the same. This neutral position is referred to as being at the money.
If your option expires in the money, you make a profit. This is known as your return. Brokers must clearly state the return you will receive on a winning binary option before you enter the contract. It is usually expressed as a percentage of your initial investment amount and will vary depending on the underlying asset, the expiry time and the broker. If, for example, you pay $100 for a binary option that has a guaranteed return of 50% if it expires in the money, you will receive your initial $100 back plus 50% of $100 – ie a return or profit of $50 – if your view proves correct.
This refers to when you make a profit on your binary options investments and decide to pull some or all of the money out of your trading account. The amount of time it takes for you to withdraw funds, as well as the cost of doing so, depends on the broker you use and the method you choose to withdraw money.
If a binary option expires at the money, many brokers will refund your initial investment. Some brokers even will even refund you a portion – typically 15% - of your initial investment, even if the binary expires out of the money. Check your broker’s policy on refunds before you enter into a contract.
Types of binary options
There are a variety of different types of binary options that you need to familiarise yourself with:
Often known as an up/down option or a call/put option, a high/low option is one of the most simple types of binary contract. With this, you simply predict whether the market price of the underlying asset will be higher or lower at expiry than the strike/target price or market price when you entered into the contract. With a high/up/call option, you expect the price to rise. With a low/down/put option, you expect it to fall.
With a one touch option, you predict that the market price of the underlying asset will reach a pre-determined level or target/strike price at expiry. This level can be either lower or higher than the market price at the time you enter the contract – the level you choose is up to you. If the market price does rise or fall to or beyond the target price, you are in the money and make a profit. If it does not move that far, you are out of the money and lose your initial investment.
A double touch option is similar to a one touch option except that here you set two different target prices. If the market price hits or moves beyond either one of these levels at expiry, your option is in the money. If it hits neither, you are out of the money.
A no touch option is similar to a one touch binary but this time you are betting that the market price of the underlying asset will not reach or move beyond a pre-determined target price during the option’s lifetime. If the market price at any point touches the target price, it immediately expires out of the money and you lose your initial investment. If it does not touch the target price, you are in the money and generate a profit.
A boundary/range instrument is a kind of binary option that allows you to predict that the market price of an underlying asset will be inside or outside a pre-determined range at expiry. To do this, you first set two different target prices – one is typically higher than the current price at the time you enter the contract and one is typically lower than this. When the market price of the underlying asset remains inside the range at expiry, it is known as an inbound option. When the market price of the underlying has broken outside the range at expiry, it is known as an outbound option.
So far you have learned that:
- you can trade almost any popular financial instrument through binary options
- you can profit from binary options if you correctly predict, whether prices will finish above or below a certain point at the expiry of the options contract
- with a ‘call’ option you speculate on rising prices, and with a put option you expect prices to fall
- the ’market price’ is the actual price of the underlying instrument, and the ‘strike price’ represents the level that is judged against the market price upon the expiry of the contract, to determine how your bet performed
- ‘in the money’ refers to an expired option that met the predefined criteria and turned a profit; and ‘out of money’ means the option did not fulfil the criteria and you need to take a loss
- there are many different types of binary options such as: high/low options, one touch options, double touch options, no touch options and boundary or range options