A binary option is a two-way option. Either something happens or it doesn't. You can choose (place a wager on) either of two outcomes. Either you win or lose.
I have not yet mentioned binary options via this blog, but have had requests to do so. Please keep in mind that binary options are much more akin to gambling than investing. This product is not appropriate for most readers, and goes against my general belief that options are best utilized to reduce risk, and not for gambling.
Currently, the Options Clearing Corporation only clears binaries traded on the CBOE because the NYSE and AMEX no longer list any binary options for trading.
Here's how a binary option, often called an 'all-or-nothing' option, works: It's a 'yes or no' proposition. For example, look at a typical call option, the SPX Oct 1100 call. If the binary version of this option is ITM when expiration arrives (remember that's Friday morning settlement), the option owner collects $100. If it is OTM, the option is worthless. That's it. It does not matter how far ITM. The payoff is zero when OTM and $100 when ITM. You get $100 whether SPX is 1100 or 1200 or 1500.
On the CBOE, there is a
market in the options, with bids and offers. If you buy or sell one of
these calls (or puts) at $50, you are getting even money on your 'investment.' The options trade
with a premium between $0.01 to $0.99, and can never be worth more than
CBOE offers Binary Options on the S&P 500 Index (SPX) and the CBOE
Volatility Index (VIX). The ticker symbols for these Binary contracts are BSZ and BVZ respectively. Expiration dates and settlement values are the same as for traditional options.
In the example, it's a wager: Will SPX be at or above 1100 at expiration? You can trade either puts or calls, so there is no concern about margin requirements when selling options. If you want to sell the call, buy the put instead.
Example: You believe SPX will be below 1100 when the settlement price is determined on Friday. You can sell the 1100 call and collect a cash premium. Or you can buy the 1100 put and pay a cash premium. Assuming these are priced efficiently, one trade is equivalent to the other. If you are correct and sold the call, it will be worth nothing and you keep your premium. If you bought the put, it will be worth $100. The profit should be the same, regardless of which option you traded.
Be aware. If the closing price is 1100.00, the call wins and the put loses. Thus, if you sold the call or bought the put, you lost.
If this gamble appeals to you, this is a reasonable wager. The risk is that the bid/ask markets are too wide and that you will not get the odds you deserve. But if you compare it with a racetrack, the house gets its 15%; if you trade with a bookie, he/she gets the vig (vigorish, or the charge taken for placing the bet), the odds available at the CBOE appear to be reasonable.
If you exit the CBOE and trade these binaries in Europe (online), the 'vig' becomes excessive. So be careful.
Where to trade
Most trading activity (as far as I can determine) for binary options occurs in Europe. You can do a Google search to find places to trade. But, I have no idea how safe it is to open an account. There is nothing similar to the OCC to guarantee the contracts.
Below is a link to EZ trader, one of the places to trade binaries. There are no bid/ask spreads. There is just a payoff percentage. When you lose, you lose 100%. When you win, you collect the stated percentage. The odds are not fair. On an even money wager, the payoff is far less.
For example, if the payoff is 65%, you either lose $100 or win $65.
Instead of choosing a strike price, they use the current price, at the time you buy your option. Then you can choose 'end of day' or a shorter time period. It looks as if that time period expires every 2:00 hours. If you are a good technician, this may be a place to gamble. I'm afraid that it's easy to get hooked.
If you are interested (despite my less than rousing endorsement), please use the link below:
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Binary options can be another way to hedge a portfolio. If you have risk at a specific OTM strike for SPX, you may be able to buy some binaries at a low price on the CBOE. That gives you limited protection. But the cost may be too high – especially when profit is limited.