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What is Digital Options Trading

Digital Options Trading – An Introduction To The New Financial Instrument

Digital options are often referred to as binary options, fixed return options or all-or-nothing options. This is because, in digital options trading, there are only two possibilities; you either make profits or nothing at all. They may have some similarities when compared with traditional options, but are different in certain ways. You are not required to have an extensive knowledge or experience of the financial markets to trade binary options. However, if you have a better understanding of the financial markets, you will be able to achieve better results when trading digital options. The aim of this article is to touch upon some of the aspects related to trading in digital options.

Binary options are made available on a variety of assets such as stocks, currencies, commodities and indexes for trading by the brokers. Further, assets from the markets around the world are also made available for trading. Digital options have a fixed payout and you will know as to how much you can earn before placing the trade. You don’t have to buy an asset as you do when trading in traditional options. In digital options trading, therefore, assets are always referred to as underlying assets.

When you trade digital options, you are only predicting whether the value of an underlying asset will be higher or lower by a specific time period referred to as the option expiry period. The expiry period can be one hour, one day, one week or even one month. The magnitude of the movement in either direction of the stock, commodity, index or currency pair does not impact your payout. As long as the direction of movement is as predicted by you, you stand to make profits. When the underlying asset has moved in the direction that you predicted by its expiry time, the option is said to expire in-the-money and the broker makes the promised payout. However, if the underlying asset moves in the direction opposite to that of your prediction by the expiry time, the option is said to expire out-of-the-money and you will lose your investment. Thus, you are clear as regards the profit or loss that a particular digital options trade can result in prior to placing the trade. This is what many investors find to be appealing when it comes to digital options trading.

Thus, the highlights of digital options trading can be summarized as follows:

* Trade in market neutral instruments.
* Fast as well as easy to trade.
* Limited risk and quantum of risk involved known beforehand.
* Trading can be started with a small initial investment.
* Brokers do not charge any commissions or fees.
* High, fixed profit payout of 60 percent to 85 percent on the amount invested in the trade.
* Pay back of up to 15%, if the option expires out-of-the-money. This feature offered by some brokers helps you to reduce your loss.
* Direction of movement more important compared to the magnitude of the movement.
* Digital options can be traded 24/7.
* You can trade on stocks, indexes, currencies or commodities.

Call Option

In digital options trading, you will set the current value of the asset as its strike price and then place a ‘call option’ if you believe that the value of the underlying asset will finish above the strike price by the expiry time.

Put Option

On the other hand, if you believe that the value of the underlying asset is going to be below the strike price at the end of the expiration period, then you have to place a ‘put option’.

Digital Options Trading – An Example

Let us assume that you have been watching the equity markets and specifically monitoring the performance of the stock Apple Inc. on the Nasdaq. You have seen a rising trend in the price of the stock and you have also read the news about the release of the next generation of the iPhone by the company. You believe strongly that the price of Apple stock is going increase for some more time.

You, therefore, decide to buy binary options on apple stock for $100. Since you expect the value of the Apple stock to increase by the end of the expiry period, say one hour in this case, you have to buy ‘call option’. Let us assume that the fixed payout promised by the broker for this particular trade is 80%. If the stock’s price is above the strike price at the end of the one-hour expiry period, you will earn profit of $80. However, if the price of the stock is below the strike price at the time of expiry, you will lose your investment.

On the other hand, if you had bought a ‘put option’ and the price of Apple was below the strike price at the time of expiry, you will earn a profit of 80% and lose your investment if at expiry Apple’s stock price was above the strike price.

As with anything in life, there are some disadvantages as far as digital options trading is concerned. However, you can easily overcome these disadvantages if you remain disciplined, take calculated risks and employ some of the key principles explained below. This will help you to reduce your losses to a great extent when you invest in binary options.

You need to always follow the eight percent rule which says that you should never invest more than 8% of the funds that you have with you at any time. You should also be prepared to suffer some losses before you can start making profits. You should not expect to have 100% success in each and every trade and it is not possible to predict the order of profitable and non-profitable trades. You need to learn to use the risk management tools provided by the digital options broker which will help you in limiting your losses on probable negative trades. You can make your account balance grow if you follow these principles and observe a great deal of discipline when investing on digital options.

December 24, 2012: posted in Binary Options Education No Comments

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