In today's financial markets, if someone wants to invest in an underlying asset, the investor has a few choices. The first and simplest choice is that of purchasing the underlying asset through one of the financial markets. This is the most capital intensive options as the investor must put up the money for the asset. There is a second way to invest in the underlying asset and that is to buy or sell options that trade in financial markets. This may be inconvenient and take time. There is another avenue that exists to allow the investor to invest in the movement of stocks. These are called Binary Options.
A Binary Option is a method of profiting from the movement in stocks without having to finance the purchase of that stock. A Binary Option has two possible outcomes (thus binary). The investor will either make a predetermined percentage profit or will lose the investment completely. There are two basic forms of Binary Options. There are "call options", for the investor who anticipates that the underlying asset will move up, and "put options", for the investor who thinks the underlying asset price will move lower. Binary Options may be a risky investment tool, but they provide high reward. The clearest way to understand the value of a binary options trade is to compare it with a straight equity purchase and a conventional option trade.
Variables:
- We are trading stock / options in Disney ("DIS")
- At 2:00 PM DIS shares are trading at $39.00 a share.
- A $100 investment will be used for these examples.
Stock Purchase:
With $100.00 you could by approximately 2.5 shares of DIS. You would own the stock at a base price of $39.00 as the stock rises you make money as it goes down you lose money. The straight stock purchase has the least risk. The stock would have to go to $0 to lose your entire investment. You could also sell the stock at any point to minimize your loss. Of course to make 70% on your investment DIS would have to trade at $67.00. This could take a long period of time or may never happen at all.
Conventional Option Trade:
A short term call option with expiration date in 3 weeks and strike price of $39.00 costs about $1.00 per contract of 100 shares, so for $100 you could by 1 contract and control 100 shares for 3 weeks. In the conventional option trade the stock would have to go up more than $1 in the 3 week period in order to generate profit. If the stock closes below $39 at the expiration date than you lose your $100.00 investment. In order to make the same 70% return the stock would have to trade at $40.70 at some point before the expiration date. Two factors mitigate the risk. The option itself is trade-able before the expiration date and you can exercise the option at any time before expiration.
Binary Option Trade:
The investor purchases a Binary Option Call at a spot price of $39.00. The option expires at 2:30 PM. If DIS is trading above $39.00 at 2:30 you make $70 on the trade in minutes! If DIS is below $39.00 at 2:30 you lose your $100 investment.
Conclusion:
The Binary Option trade carries the highest short term reward. A return of 70% on your investment in a half hour. The trade off for this high reward is the risk of losing your $100 investment in the same period if the stock does not go above $39.00.
