The most common definition found for an option is that it is an investment instrument (generally a contract) in which a trader purchases the option to buy or sell the underlying asset. In layman's terms, the owner of a stock writes a buy (call) or sell (put) option on shares of that stock; an options trader purchases the ability, but not the obligation, to buy or sell the writer's offered shares. The writer is obligated to conduct the transaction if the trader exercises the right they purchased.
These options are then traded between investors, varying in price with the asset they are based on. Nadex binary options, however, have fixed payouts—this means the investor will receive either all or none of the profit—and are popular because they are relatively easy to understand.
Binary options have complications when purchased outside of the U.S. There is not as much regulation, opening the doors for fraudulent activities. Authorities advise staying away from foreign binary options presented via websites. This means that if you want to trade binary options in the U.S., you'll likely be trading "Nadex options." Nadex is the primary binary options exchange in the U.S. Here's a basic rundown of how these binary options work.
- Unlike regular stock options with varying prices, binary options have fixed payouts of either all or none of the profit.
- U.S. investors who want to engage in binary option trading usually trade on the Nadex market.
- Nadex binary options are wagers that a price of an asset will be above or below a named price when the option expires.
- The structure is transparent, and each option has a price, underlying asset, and an expiration. Holding the option until expiration isn't required.
- You can open a basic trading account for as little $250, and while there are no trading minimums, you must have the capital available to cover the maximum risk on each trade you take.
Binary Options in the U.S. (Nadex)
A Nadex binary option is a wager that the price of an asset will be above or below a specific price (called the strike price) at the time the option expires. For example, a trader would consider if the price of gold would be above a $1,550 strike price at 1:30 PM (the option expiration time). If the trader thought it would be, they would buy the option. If they thought it wouldn't be above the strike price, they would try to sell any options they had.
Binary options are written for stock indexes, forex (currencies), commodities, news events, and bitcoin, with various strike prices and expiry dates or times. This makes them suitable for day traders and swing traders as they are geared towards the short-term.
The binary options are priced between $0 and $100. When the option expires, it's worth either $0 or $100, depending on whether the underlying asset is above or below the strike price when the option expires. The price of the option is set by the buyers and sellers of the option contract and represents the approximate odds of the price reaching $0 or $100.
Binary options trading is much like visiting a casino, you are playing the odds.
For example, if the option is trading at $50, then traders view the odds of the option expiring at $0 or $100 as equal. If the option is trading at $20, traders view the odds of the option expiring at $0 as greater than expiring at $100.
You can buy, sell, close or hold an option at any time, at any price available, up until expiry. Should you choose to hold, the option will either be worth $0 (good if you sold options) or $100 (good if you bought options).
Maximum Profit and Loss
Profits and losses are created based on the difference between the expiry price, and the price at which you buy or sell the option.
If you buy an option—expecting the price of the underlying asset to be above the strike price at expiry—your maximum risk is your purchase price minus $0. For example, if you buy an option at $45, your maximum risk is $45 (you have risked the money you used to purchase the option). Your maximum profit is $100 minus your purchase price. In this case, your maximum profit is $55 (if the option maxes out).
|Purchase Price||Risk||Expiry Price||Max Profit||Loss|
|Sell Price||Risk||Expiry Price||Max Profit||Loss|
If you sell a Nadex binary option—expecting the price of the underlying asset to be below the strike price at expiry—your maximum risk is $100 minus your sale price. For example, if you sell an option at $35 your maximum risk is $65. Your maximum reward is your sale price minus $0—in this case, $35.
Every dollar the option contract moves is worth $1 in profit or loss. You can buy or sell multiple options to increase or decrease your gain or loss. For example, if you buy three Nadex binary options at $40, your maximum risk is 3 X $40=$120 and your maximum gain is 3 X $60 = $180. Try to keep your risk on each trade to small percentage of your account's capital.
Each trader is responsible for providing the capital to fund their trade. If you buy an option at $50, your maximum risk is $50. You need to have at least $50 in your account to fund the trade. The seller of the option, also risking $50, must have at least $50 to fund the trade.
The minimum deposit required to open a Nadex account is $250 (for direct trade members), although no minimum trading balance is required once the account is open since you can only open positions if you have enough capital.
FCM and Market Maker members are required to maintain minimum balances starting at $100,000 but have no membership fees.
Trading fees are $1 per option to enter or exit, and a $1 settlement fee per option (if in the money) at expiry, depending on the order lot sizes. Lots of 1 to 50 are charged the fees, and lots of 51 or over are not.
There is no charge if you are out of the money. (Out of the money means the strike price is above the market value, in the money means the strike price is below the market price.) Fees are charged to enter and exit positions. If you hold an option until expiry and lose, you are not charged the exit fee. Nadex offers a demo account where you can try binary options trading risk-free.