Binary Options or Forex

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  • Binarium
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  • Binomo
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Binary Options Vs. Forex

Binary options trading has long existed over-the-counter, only experiencing a massive growth spurt in the last few years.

Now, approximately 90 companies (including those who white label their products) offer some sort of binary options trading service.

So okay, it’s a growing industry… But why should you involve yourself in it?

There are many advantages and disadvantages to both binary options and spot forex.

Max Risk

One of the great things about binary options trading is that you always know the exact maximum gain or loss in advance.

The trader controls the premium at risk to enter the binary option trade, and that is the only amount that can absolutely be lost.

Most binary option brokers even allow you to cut your max loss by “folding” your trades ahead of expiration after certain types of trade conditions have been met.

In contrast, with spot forex, even with a stop loss order set, you cannot be 100% certain that you will lose only the pre-calculated amount that you risked.

While improbable, there’s always the chance that certain issues may affect your final max risk like slippage, lack of liquidity to execute a stop order at the desired price, a broker’s trading platform goes down, etc.

Trade Management Flexibility and Maximizing Reward

Aside from High/Low options, many of the binary option plays are only available at certain times of the day or week, and most times the strike prices are set by the broker.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
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  • Binomo
    Binomo

    2nd in our ranking!

With spot forex, you are able to enter limit orders for any price or execute a market order at any time during open market hours.

In terms of exiting open trades, some binary options brokers allow you to close options trades early, but usually only after a predetermined amount of time has pass after the option trade has opened and before it closes.

And as mentioned before, the value that is returned to the trader is based on whether the market is in-the-money or out-of-the-money and of course, with a piece going to the broker.

In spot forex, you can close your trade at any time (except on weekends with most brokers). Even if it’s one second into the trade, you can get out and book profits or reduce losses.

Finally, if you think there’s going to be a long trend and you want to maximize your profit on it by holding it as long as possible, you can do so in the spot market using scaling in and trailing stop techniques.

With a binary option, the expiration date and cap on profits limits you; you’re out of the trade as soon as you close or the option expires.

Depending on your risk and trade management preferences, either trading instrument can be good or bad depending on how much time you want to spend in front of your trading platform, how active you want to be, or what you expect the market may do.

Transaction Costs

In binary options trading, there are no additional transaction costs other than what is normally factored into the final payout.

In spot forex, the transaction cost comes in the form of a spread, a commission, or both. We’ve already discussed this in a previous chapter, but feel free to revisit the lesson and read up on it again.

Trade Choices

Another great thing about binary options trading is that you aren’t limited to just currency pairs like with most retail forex brokers.

While currency pairs are the most common assets you can trade, with some binary options brokers, you may also have the opportunity to trade your ideas on a limited number of individual stocks, stock indices, and even commodities.

Volatility Risk

Surprise volatility is not usually an issue in binary options trading. Any trade you take can weather the volatility caused by certain events.

The max risk is still set, but so is the max reward.

In spot forex, however, sharp swings can affect the value of a position greatly and very quickly, which makes the additional task of setting up proper risk management processes very important.

Trader Error

The margin for error when entering a trade is very small in binary options trading.

This is due to the fact there are only two actions to take with binary options: open and close.

There are no limit orders to keep track of, or to close or adjust. In spot forex, an inattentive trader may forget to place exit and/or adjustment orders, potentially creating a loss greater than he/she intends.

Binary Options vs. Forex Trading: Understanding the Difference

Forex trading and binary trading are quite different and it is important to understand these differences in order to become

The article was written by Connor Harrison from Binary Brokers (BBZ). BBZ makes an effort to educate their traders so that they can understand recommendations regarding binary options, international legislation, risk management and other issues related to trading.

Binary options are option contracts with fixed risks and fixed rewards. In binary options trading, the trader must decide whether an underlying asset, such as a stock, a commodity, or a currency, will go up or down during a fixed period of time. Traders are shown up front the value of their earnings if their predictions are right.

Roulette

Binary trading works in much the same way as a roulette: if your prediction is wrong, you lose all the money you risked, but if your prediction is right, you receive your money back plus a return. A common set-up is for the trader to make 80% of what they bet on any trade that they get right. For instance, if a trader puts in $10 dollars betting on the value of the USD/EURO going up, and the guess is correct, he would receive $8 dollars plus his initial investment. If the value of the same currency drops, however, the trader loses 100% of the money that they put in.

Connor Harrison, BBZ

To make money in binary options in the long run, you must win the majority of the bets. Since forex trading allows users to set their own profit targets vs. stop loss orders, traders can still make a profit even if they do not win the majority of their trades.

There are of course some similarities between binary trading and forex trading. Both financial trading markets are tradable online, and they both allow users to start trading with small amounts of capital.

In both types of markets, users are speculating on which direction an asset moves in. In the case of guessing correctly, both trading options provide strong profit potential.

However, there are some differences between binary options and forex. In a binary market, traders only guess whether an asset, such as a foreign currency, will go up or down in value over a fixed period of time. In this sense, there is no variability in the risk or in the profit potential. The binary market is named after the binary system, in which the only two input options are 1 or 0. Similarly, in binary trading, the only two options are up and down.

Higher variability, more risk

Forex markets offer higher variability and more risk for traders. In forex markets, sometimes known as FX markets or currency markets, traders must decide not only in which direction as asset will go, but must also predict how high or low that asset goes. Thus, the ultimate risk and profit is unknown.

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In forex, there are no limits to how much money a trader can make or lose, unless they use certain tools to control trading. One tool is a stop loss, which prevents traders from losing more than a certain amount. In other words, once the trader has lost a certain amount, the trade automatically closes. Similarly, the potential reward may also be fixed beforehand. The trader can decide that he wants the trade to close once it has reached a certain profit value.

The maximum loss in forex would be all the money on your trading account. In forex, both losses and profits can be managed with limit/stop orders.

Timelines

Binary trades operate on specific timelines. The trader has no control over when a trade begins or ends once a trade has started. Before a binary options trade begins, users must select when the order expires. Each option has a start time and an end time.

At the expiry time, the trade automatically closes. Some brokers allow you to close early but you will exit your option at a percentage of the expected return. Not all brokers offer this option.

Similarly, some brokers allow traders to delay the expiry time to the next expiry time. This is called “rollover” and is only possible if traders increase their investment by a certain percentage.

In forex trading, users can take trades lasting from one second to many months, since they can open and close the trade whenever they feel like it. This flexibility has both advantages and disadvantages.

Margins

Forex also has a tool called margins. Each broker determines the maximum margin. Margins allow traders to increase their investment capital so that they can make a larger profit if the trade is a winning one. Margin is not a tool available for binary options.

There are five types of binary options you can trade. These are high/low, 60 seconds options, touch/no touch options, boundary options, and option builder. There are many different types of orders in forex. Buy/sell are the most important type. However, there are more advanced types such as limit, stop, OCTO (one cancels the other), trailing stop, and hedge orders, among others.

Forex trading and binary trading are quite different and it is important to understand these differences in order to become a successful trader.

Trading Forex with Binary Options

Binary options are an alternative way to play the foreign currency (forex) market for traders. Although they are a relatively expensive way to trade forex compared with the leveraged spot forex trading offered by a growing number of brokers, the fact that the maximum potential loss is capped and known in advance is a major advantage of binary options.

Defining Binary Options

Binary options have two outcomes: They settle either at a pre-determined value (generally $100) or at $0. This settlement value depends on whether the price of the asset underlying the binary option is trading above or below the strike price by expiration.

Binary options can be used to speculate on the outcomes of various situations: Will the S&P 500 rise above a certain level by tomorrow or next week? Will this week’s jobless claims be higher than the market expects? Or will the euro or yen decline against the U.S. dollar today?

For example, say gold is trading at $1,195 per troy ounce currently and you are confident that it will be trading above $1,200 later that day. Assume you can buy a binary option on gold trading at or above $1,200 by that day’s close, and this option is trading at $57 (bid)/$60 (offer). You buy the option at $60. If gold closes at or above $1,200, as you had expected, your payout will be $100, which means that your gross gain (before commissions) is $40 or 66.7%. On the other hand, if gold closes below $1,200, you would lose your $60 investment, for a 100% loss.

Binary Option Buyers and Sellers

For the buyer of a binary option, the cost is the price at which the option is trading. For the seller of a binary option, the cost is the difference between 100 and the option price and 100.

From the buyer’s perspective, the price of a binary option can be regarded as the probability that the trade will be successful. Therefore, the higher the binary option price, the greater the perceived probability of the asset price rising above the strike. From the seller’s perspective, the probability is 100 minus the option price.

All binary option contracts are fully collateralized, which means that both sides of a specific contract – the buyer and seller – have to put up capital for their side of the trade. So if a contract is trading at 35, the buyer pays $35, and the seller pays $65 ($100 – $35). This is the maximum risk of the buyer and seller and equals $100 in all cases.

Thus the risk-reward profile for the buyer and seller in this instance can be stated as follows:

Buyer

  • Maximum risk = $35
  • Maximum reward = $65 ($100 – $35)

Seller

  • Maximum risk = $65
  • Maximum reward = $35 ($100 – $65)

Forex Markets

Binary options in forex are available from exchanges such as Nadex, which offers them on the most popular pairs such as USD-CAD, EUR-USD, and USD-JPY, as well as on a number of other widely-traded currency pairs. These options are offered with expirations ranging from intraday to daily and weekly. The tick size on spot forex binaries from Nadex is 1, and the tick value is $1.

The intraday forex binary options offered by Nadex expire hourly, while the daily ones expire at certain set times throughout the day. The weekly binary options expire at 3 P.M. on Friday.

For forex contracts, Nadex calculates the expiration value by taking the midpoint prices of the last 25 trades in the forex market, eliminates the highest five and lowest five prices, and then takes the arithmetic average of the remaining 15 prices.

Examples of Binary Options in Forex

Let’s use the EUR-USD currency pair to demonstrate how binary options can be used to trade forex. We use a weekly option that will expire at 3 P.M. on Friday, or four days from now (or Monday). Assume the current exchange rate is EUR 1 = USD 1.2440.

Consider the following scenarios:

1. You believe the euro is unlikely to weaken by Friday and should stay above 1.2425. The binary option EUR/USD>1.2425 is quoted at 49.00/55.00. You buy 10 contracts for a total of $550 (excluding commissions). At 3 P.M. on Friday, the euro is trading at USD 1.2450. Your binary option settles at 100, giving you a payout of $1,000. Your gross gain (before taking commissions into account) is $450, or approximately 82%. However, if the euro had closed below 1.2425, you would lose your entire $550 investment, for a 100% loss.

2. You are bearish on the euro and believe it could decline by Friday, say to USD 1.2375. The binary option EUR/USD>1.2375 is quoted at 60.00/66.00. Since you are bearish on the euro, you would sell this option. Your initial cost to sell each binary option contract is, therefore, $40 ($100 – $60). Assume you sell 10 contracts, and receive a total of $400. At 3 P.M. on Friday, let’s say the euro is trading at 1.2400.

Since the euro closed above the strike price of $1.2375 by expiration, you would lose the full $400 or 100% of your investment. What if the euro had closed below 1.2375, as you had expected? In that case, the contract would settle at $100, and you would receive a total of $1,000 for your 10 contracts, for a gain of $600 or 150%.

Additional Basic Strategies

You do not have to wait until contract expiration to realize a gain on your binary option contract. For instance, let’s say by Thursday the euro is trading in the spot market at 1.2455, but you are concerned about the possibility of a decline in the currency if U.S. economic data to be released on Friday are very positive. In this case, your binary option contract (EUR/USD>1.2425), which was quoted at 49.00/55.00 at the time of your purchase, is now at 75/80. Therefore, you could sell the 10 option contracts you had purchased at $55 each, for $75, and book a total profit of $200 (or 36%).

You can also put on a combination trade for lower risk/lower reward. Let’s consider the USD/JPY binary option to illustrate. Assume your view is that volatility in the yen – trading at 118.50 to the dollar – could increase significantly, and it could trade above 119.75 or decline below 117.25 by Friday. You, therefore, buy 10 binary option contracts (USD/JPY>119.75, trading at 29.50/35.50) and also sell 10 binary option contracts (USD/JPY>117.25, trading at 66.50/72.00). Therefore, you pay $35.50 to buy the USD/JPY>119.75 contracts, and $33.50 (i.e., $100 – $66.50) to sell the USD/JPY>117.25 contracts. Your total cost would be $690 ($355 + $335).

Three possible scenarios arise by option expiration at 3 P.M. on Friday:

  1. The yen is trading above 119.75. In this case, the USD/JPY>119.75 contract has a payout of $100, while the USD/JPY>117.25 contract expires worthless. Your total payout is $1,000, for a gain of $310 (or about 45%).
  2. The yen is trading below 117.25.In this case, the USD/JPY>117.25 contract has a payout of $100, while the USD/JPY>119.75 contract expires worthless. Your total payout is $1,000, for a gain of $310 (or about 45%).
  3. The yen is trading between 117.25 and 119.75: In this case, both contracts expire worthlessly and you lose the full $690 investment.

The Bottom Line

Binary options are a useful tool as part of a comprehensive forex trading strategy but have a couple of drawbacks in that the upside is limited even if the asset price spikes up, and a binary option is a derivative product with a finite lifespan (time to expiration).

However, binary options have a number of advantages that make them especially useful in the volatile world of forex. For starters, the risk is limited (even if the asset prices spikes up), the collateral required is quite low, and they can be used even in flat markets that are not volatile. These advantages make forex binary options worthy of consideration for the experienced currency trader.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
    Get a Sign-Up Bonus Now!

  • Binomo
    Binomo

    2nd in our ranking!

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