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What is a Binary Option?
Updated at April 17th, 2022
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This is a financial derivative which has a fixed payout if an option expires in the money and the risk of losing all the money invested in the option if it expires out of the money. Since it is called a binary option, its success depends on a yes or no proposition. The binary options have an expiry date, and when it arrives, the price of the underlying asset must be on the right side of the strike price for it to make a profit. When the option expires, the loss or gain is automatically credited or debited in the trader's account.
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Binary options are simple. For example, Will the share price of ABC Company be above $25 on March 1st at 2:40 pm? What the trader has to do is to select yes to mean it will be higher or no to suggest it will be lower and then stake the amount he willing to bet on the answer. Suppose the trader chooses yes and stakes $100 and the payout established is 70%. If on that date and time the shares go above $25, a profit of $70 is credited to the trader's account. If the price falls below $25 at that date and time, the trader loses the total investment of $100. The holder of the option may be given the right of buying or selling an underlying asset at a certain price before the expiration date of the option by a vanilla American option. A European option is similar, but the right can only be exercised on the expiration date. Buyers are provided by vanilla options the potential ownership of the underlying asset. During the purchase of these options, the risk is capped although the profits shift depending on how further away the price of the underlying asset is. Binary options are fixed since they don't provide the possibility of taking a position in the underlying asset. They have a fixed payout and fixed maximum risk that is limited to the amount invested in the binary option. The movement of the underlying asset does not affect these payouts or losses. The only factor affecting the profit or loss is whether the price of the underlying asset is on the right side of the strike price. However, some binary options can be closed before expiration, but this action reduces the payout received. In the US, binary options are usually traded on platforms which are regulated by the SEC and other regulatory agencies. Most of the binary options trades that occur outside the US are not typically regulated. Investors are advised to be wary of the binary options brokers who are not held to a particular standard since they operate unregulated.