Before moving in to an overall introduction of modern option trading we should explain that the overall idea of this form of trading allows the trader to select the possible direction of a particular security within a predefined period of time. In simple everyday language the overall concept of binary options or options trading is that a security e.g a particular stock price can only move in two directions at any future given time.
This movement could be an uptrend movement or a downtrend movement respectively. In options trading the trader has the opportunity to invest in a speculation of the future movement with a predefined yield for a correct speculation. However unlike other forms of investments or other forms of trading in binary options trading a mistaken speculation will follow the cash or nothing rule; meaning that the investor will either receive a predefined lump sump return on his investment or will either lose his investment in total.
The overall concept of modern online option trading is at the overall extent the same as classic stock option trading with the difference that along with the revolution of currency trading online options trading has diversified to forex option trading where investors have the opportunity to speculate on the movement of a particular currency pair at a predefined time in the future. The overall concept is exactly the same as classic American stock option trading with the primary difference that in its modern online era options trading has found its place in currency trading, futures trading and CFD trading.
Although nowadays binary options trading is considered to be one universal form of trading from origin there is a major differentiation between American options and European options which although very much related forms of investments poses one major difference.
American Options Vs European Options
Unlike European options, American options allow the investor to exercise the call option at anytime between the period on which the investor has selected to make his speculation and the time in which the option is set to mature therefore in some cases allowing the investor to buy out his risk on time before his investment is eventually worth nothing at all. Needless to say the American options pattern is mostly applicable in cases where securities have a long term maturity timeframe which is mostly seen in stock option trading than forex options where the predefined timeframe is usually very short term.
The overall move towards today’s forex options format is primarily due to 2 main factors which have made the classic types of stock options trading incompetent;
- The excessive liquidity of the forex market
- The increasing exposure of forex as a concept of trading on the Web.
It is only reasonable to say that in order for the concept of options trading to function as a high risk, high return investment the presence of a fast moving market for a particular instrument or security is needed in order to make the overall ratio of risk to return higher and therefore the overall possibility of the particular type of investment more attractive.
With the booming and revolutionary presence of forex trading online the forex market has presented figures exceeding $4 trillion worth of transactions executed over the counter day in day out therefore making the market more dynamic, more turbulent and more rewarding than ever.
Taking into consideration what we have mentioned above it is only reasonable that classic stock option trading with a 3-6 months maturity date on only certain liquid stocks including S&P 500 stocks has been forced incompetent by a market which allows forex options with a maturity 1 minute ahead of time.
Example of a Binary Options Trade
An example of a binary option trade in the format which is becoming increasingly popular today is as follows; after assessing the market an investor may believe that the EUR/USD currency pair will close at a price equal or above 1.3890 at 3am and may select to buy a so called call option on the particular speculated outcome or he may select to purchase a put option if he believes that the outcome of the EUR/USD currency pair will close at a price equal or below 1.3889.
In both cases the investor places an all or nothing investment with the risk involved known to him; simply said if his speculation turns out to be correct at any of the two scenarios above the investor will receive a predetermined amount of yield or alternatively will lose his initial investment. However in certain cases and in certain forms of binary trading the predetermined maturity date can be a time in the future which might have a semi-long term maturity therefore allowing the investor to liquidate before maturity of the contract and buy out his risk at a predefined rate which changes as the maturity timeframe becomes thinner. It is important to note that at any given time the current market price of the EUR/USD currency pair is called the spot price. All the above may apply for futures trading or CFD’s in addition to currencies.