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Binary Options Trading
What is Binary Options Trading
A binary option is a contract that gives the buyer the right but not the obligation to buy the underlying security at a specific price before on a specified date. If this is your first time reading about binary options you may still be a little confused as to how they work. Here is a simple example using real estate options that should help clarify the situation.
For example if you wanted to buy a hotel that cost $10,000,000 you might not have all of the money available right now. You might need financial backers but while you were arranging this you don’t want to lose out on the chance to buy the hotel. So instead you purchase the option to buy the hotel.
You might agree for example until January 1st you will have the option but the obligation to buy the hotel. Of course the current owner of the hotel wants to be financially compensated for providing you with this option. Over this period they can’t sell the hotel to anybody else and so you offer then $50,000 for the option to buy the hotel. This $50,000 is the option price.
Your major risk as binary option investor is the time risk. This is because an option is a contract for a limited time period. For example if you have a call option to buy Coca Cola stock for $80 a share in two months time and the current price is $70 then you need the stock to move above that strike price of $70 in the next two months. If it fails to do so then your options will expire worthless.
If the options do eventually rise above $80 a share say three months later it will unfortunately be too late for you to profit. If instead you had bought the stock instead of the option you would still have benefited from this move later on.
A call option increases in value when the value of the underlying stock goes up. The reverse of this is a put option. With a put option you have the right but not the obligation to sell a particular stock.
The key point is though that in both types of options the primary risk is the time factor. The move up or down must occur before the specified date or your options will be worthless.
Participants in the Option Market
There are four basic participants in the market that you need to be aware of. These are:
• Call option buyers
• Put option buyers
• Call option sellers
• Put option sellers
In order for there to be an option someone must first “write” that option. These are the call and put option sellers which are also known as option writers. The buyers are known as option holders.
There is an important distinction between the two parties which you must be aware of. This is that while a call or put option buy has the right to buy or sell a particular security they are not obligated to do so. However a call or put option seller must fulfill their end of the bargain.
Key Binary Options Trading Terms
Like any technical field there are certain terms you will need to acquaint yourself with when you are trading options. Here are the basic terms that you need to know when you are starting out.
Strike Price: This is the price that the underlying stock can be sold or bought at. For example if a Coca Cola call option has a strike price of $80 then this means that the Coca Cola stock can be bought at $0 a share no matter what the current price of the stock might be.
Exercised: This is when you take up your right to either buy or sell the underlying security of the option.
Exercise Date: This is the date that the option must be exercised on or before.
In-the-money: An option is in-the-money for a call option if the underlying stock is above the strike price. For example if a Coca Cola call option has a strike price of $80 and the current stock price is $85 then this option is in-the-money. For a put option the reverse is true. So if the current price of the stock is below the strike price then it is in-the-money.
Premium: This is the total price of the option.
Types of Options
There are two basic types of binary options. These are:
European Options: With European options they can be exercised only at their expiry date.
American Options: These options can be exercised at any point up to and including their expiration date.
The other type of option that you need to be aware of is Long Term Equity Anticipation Securities (LEAPS) these are exactly the same as a standard option but they have much longer lives. You can use these in the same way as you would with a standard option to either speculate or to hedge your positions long terms. LEAPS are not available for all securities but they can be obtained for most.
Binary Options Trading Advice
Don’t buy options in the last month
As an option buyer time is your friend. The longer the amount of time until the expiration date the greater the chance that the underlying stock will reach the strike price.
For this reason you should never buy options which are less than one month from expiration. There simply is not enough time for the underlying stock to cross over the strike price. Often you will find yourself making the right call about the direction of the stock but it will not occur before the option expires.
Don’t put all of your eggs in one basket
At times as a binary option trader there will be opportunities that seem so overwhelmingly attractive that it would seem foolish to pass them up. And you may have actually identified a real opportunity but remember that with options trading it is not just a matter of being right. It is being right in the right time frame.
Remember that the market can always surprise you so don’t try and go for the big killing. Nobody has a crystal ball telling them what is going to happen tomorrow and a lot of people have gone broke in the market in the belief that they did. So with your options trading you should never place all of your money in a single trade no matter how attractive it seems.
Don’t do what everyone else is doing
If there was a formula for mediocre or even subpar performance it would be to follow what everyone else is doing. Most people who invest in the stock market or trade options will lose money. And that includes the professional fund managers.
This is in part because we are affected by group physiology. When the market is booming and everyone is optimistic about stocks we tend to be as well. This means that we tend to buy at the top of the market.
Scale Out of Winning Positions
There is nothing worse than seeing a paper profit float away from you. This is why it is important to scale out of positions as they go the way that you planned for them.
When the stock price is moving in a favorable direction, sell out some but not all of your options in that position. As it moves further in the desired direction sell out more. Leave only a handful for the chance that the trade will work out incredibly well.
This will mean that you never miss out again on profits that you could have had but then had the trade turn against you.
When buying options go big or go home
Most options will expire worthless. This is a fact that you must always keep in your mind when buying options. If you try and make small wins when buying options the math is eventually going to catch up with you and you will lose money.
If you are buying options look for the big wins. Most of the time you will lose but once in a while an option will pay off so well that it will make up for all of the smaller losses. The stock market can be at times very volatile. Who would have imagined that the stock market could drop so suddenly to just over 6000 when it had been so recently as high as 13000. You can use this volatility to your advantage by purchasing.
Making Money Writing Covered Calls
Writing covered calls can be a great way to make an income owning stocks that you already love. Writing covered calls can create a win – win situation where if the stock meets the strike price you sell out for a price that you are already happy to get. And if the strike price isn’t reached you can keep the premium for writing the option.
A covered call option takes its name from the fact that the binary option is covered by the stock that you already own. You already have in your possession the stock so if the option is exercised you can provide this stock.
Buying Low Priced Stocks
If you decide that you want to try writing covered calls then you should look at stocks with a low price. The premium offered calls on low priced stocks tends to be higher as a percentage of the purchase price.
However if do decide to purchase low priced stocks for the purpose of calls keep in mind that you should never buy a stock solely because the share price is low and you want to be able to collect the premium that is offered. Remember that your potential loss is your entire investment in the stock if the company was to bankrupt.
Study and learn as much as you can about binary options trading. But also you must get started at some point. Until you put money on the table and you start taking risks you will never learn what it is really like to be an option trader. Also having real money at risk is a very good motivator to learn.