How to trade Binary Forex Options

During the past few years binary options, which were mainly a product available only to institutional clients, have become available to the retail market and professional traders.  Binary options are “all of nothing “options, which give the investor a fixed payout if the criterion of the option is met.  Binary, means two parts, a portion that is in the money, and a portion that is out of the money.  Binary options are listed on many currencies and indexes, but at this point currency binaries are only available through the over the counter market.  There are a few different styles of binary options that focus on trading the currency markets.  These types of options are “above or below” options, “range” options “and “one touch” options. 

Binary Currency Options, which are also known as digital options or all or none options, are a new exciting way to trade the currency market.  What makes these investment vehicles interesting is that the investor receives a fixed payout as a return based on whether the currency market meets specific criteria that is described as part of the option definition.  Within each option definition (above or below, range and one touch), the specifics of how the option pays out, and the payout profile is described.

The most common of the binary currency options that are available to trade is the “above or below” option.  This type of option allows an investor to speculate a dollar amount (or base currency amount) instead of a lot size on the immediate direction of a currency pair.  Most of the options that are available have a time limit that is less than a few hours, but theoretically, there can be options with expiration as long as a month or more.  Most of the dealers or brokers in this industry require a minimum of $100 (or base currency) US dollars to speculate on a binary option. The above or below option, (which is also listed as a call for above and a put for below) lists a strike price which the market will need to be above (for the call) or below (for the put) for the option to pay out to the investor.  Any example of a trading screen from Anyoption (one of the options brokers) is listed below.  

In the upper left, the currency pair is listed, and in the upper right, the expiration time and date is listed.  Below the currency pair, the option describes the payout.  The payout in this example is 70% of the original investment plus the initial investment.  A winning trade with a $100 dollar investment would add $70 dollars to the $100 initial investment.  The loss on an unsuccessful trade is $85 dollars.  Although the risk reward on the speculation is less than 1:1 (70% on a winner and 85% on a loser), binary option has many excellent benefits, which is addressed within this article.  To trade this style of option, an investor needs merely to click on the up arrow for a call and a down arrow for a put.  The strike prices on these options are constantly changing while the option is live.  On most of the platforms, the options terminate active trading approximately 15 minutes before the expiration of the option.  In example above, option trading on the above or below option would end at 11:45 AM.

Another type of binary option is the range option, which allows a trader to determine if the underlying currency pair will “hit” or “miss” a specific range.  The range option creates a payout if the underlying asset is in a range (hit) or out of a range (miss).  In some cases, the ranges are specific, and are set by the broker, and in other cases, the investor can draw the ranges and the broker then lists the payout profile.  The payout profile on range options can be different from an above or below option, since the area that the underlying market needs to hit (or miss), can be a percentage away from where the actual market is trading.  For example, in the graph below (and hourly chart of GBP/USD) a range-hit box can be placed where the payout is 1.5 to 1 if the market hits the specific area denoted by the range.  The further the range is from the underlying asset, the higher the payout will be for a hit (and the lower for a miss).  The range is not only a price range; it is also a time range.  The longer the time range for the binary option, the lower the payout will be if it is hit.  The trade terminates either when the range is hit, or when the end of the range box, in reference to time is met. The payout profile on a range box will have a number of factors, which include the distance from the current underlying asset, the price range and the time range.

A third type of binary option is the “one touch” option.  This option pays off if the underlying market touches a specific point at any time during the life of the option.  The one touch options  is slightly different that the above or below.  The payoff for these options is higher (75%) if the market touches an area that is above the market on a touch up or below the market on a touch down at any time price to the expiration of the contract. 

The benefits to trading Binary Forex Options relative to other instruments are numerous, as these types of options provide a dynamic trading environment and a flexible trading instrument. Additionally investors do not have to contemplate a number of different issues that occur when trading standard options.  There is no exercise into a different product to worry about, and there is no hedging of Greeks, the investor either receives a payout or does not.  The characteristics of binary options allow an investor to know how much is being risks (notional amounts) on each trade, and to understand specifically what he will make on each trade.  There is no additional margin that needs to be called if the trade is a losing trade.  The instruments used to trade are a notional amount of money in contrast to the underlying instrument, which enables investors to enhance their profits by requiring far less capital than standard trading methods.  Profits are also magnified in binary options trading because very small moves will create the same gains that large moves create when trading standard vanilla options.  Binaries are also very simple to trade and rely on the actual price instead of the difference in prices.  The platforms that the majority of these options are traded on are straightforward and simple to use.