The principle of binary options comes not from the world of finance, but rather from the world of gambling/betting. A binary option is an all-or-nothing bet that expires either in the money or worthless — only two outcomes are possible. Binary options in Forex are over-the-counter and usually are not traded on an exchange. In contrast to the "vanilla" options, binary options are considered a form of “exotic” option.
Binary options are usually European style, meaning they can be exercised (or rather will be exercised on your behalf) only on the expiration date, although some brokers will allow you to close the position early. One of the types of binary trades that operate on the American options basis is a “one-touch” binary option. Also, some brokers will allow you to rollover the trade, but often only if you increase the stake.
One benefit of binary options is that you know exactly in advance what you maximum gain and loss will be, whereas in regular Forex trading, you know that trade-off only if you have set a stop and target that gets filled precisely as you order. Each broker has its own rules as to minimum (and maximum) trade size, and these may vary from the regular contract sizes in the Forex market ($1,000, $10,000, and $100,000). Margin is not used in binary options and so you will never get a margin call.
Binary options brokers do not, on the whole, charge a commission or spread (although Nadex does — see below) — they make their profits from the preponderance of options that expire out of the money. This tells you immediately that binary options is betting and not trading. In fact, the chief criticism of binary options is that the platforms offering them are “gaming” platforms because the broker has a net cumulative advantage over the trader, like a casino or bookie.
And yet from the trader’s point of view, the simplicity of binary options is more important than how the broker makes his living – not dealing with margin, commissions/spreads, and fixed amounts, even being able to select the hour and not just the date. A Forex trader with genuine forecasting capability can trade profitably with greater efficiency. Binary options may be useful as an alternative or supplement to a stop, or a method to scale in to a position before committing fully to it.
Say that you have studied the chart of EUR/USD and feel convinced it will rise to 1.3850 or more by noon tomorrow. You buy a call option when the price is 1.3800 for a premium cost of $100.00. If the strike is hit, you will make $190 for a net gain of $90.00.
If you believe the price will fall, you could buy a put. That is, you can have a Call/Up or a Put/Down (also named High/Low). Several other fancier types of binary options are available in Forex, too, including a 60-second version (for which programmers have devised automated programs).
The one-touch option uses a specific price that must be met (or not met, as the case may be) over a specific time frame. The broker/platform offers a range of possible futures prices and it is up to you to decide if the level will be reached over the upcoming week or other period. Say, EUR/USD has fallen off a cliff and you believe it will pull back to the upside. The euro closes at 1.3704 on Friday. You have the choice of a one-touch call that specifies the EUR will rise to touch 1.3730 at least once in the upcoming week (or a one-touch put that it will fall to 1.3675 at least once in the upcoming week). The selling point for one-touch options is that it literally takes one touch to go in-the-money.
Even if you are clever with options probabilities and bookmaking odds, you should read the broker’s fancy options descriptions and conditions very carefully.
A useful way to apply binary options is to devise what is really a straddle out of an underlying position in the currency plus a binary option in the opposite direction. Say, you are short the GBP in the spot market at a support level you consider will get broken to the downside. But a surprise can always come along and so you want protection against an upside move, say at a resistance level. You would buy a binary call at resistance.
In the USA, the Securities and Exchange Commission and the Commodity Futures Trading Commission issued a joint warning against unregulated binary options brokers. A key issue is that on non-regulated platforms, clients’ money is not necessarily kept in a trust account, as required by government financial regulation, and transactions are not monitored by a third party to ensure fair play. The investor alert says:
There are currently are only three designated contract markets offering binary options in the U.S.: Cantor Exchange LP; Chicago Mercantile Exchange, Inc.; and the North American Derivatives Exchange, Inc. All other entities offering binary options that are commodity options transactions are doing so illegally.
Any US broker or platform offering binary options in Forex should be a registered Futures Commission Merchant. To make the point even more firmly, the advisory goes on to say:
Because of their lack of compliance with applicable laws, if you purchase binary options offered by persons or entities that are not registered with or subject to the oversight of a U.S. regulator, you may not have the full benefit of the safeguards of the federal securities and commodities laws that have been put in place to protect investors, as some safeguards and remedies are available only in the context of registered offerings. In addition, individual investors may not be able to pursue, on their own, some remedies that are available for unregistered offerings.
In the USA, as of the fourth quarter of 2016, the main marketplace for Forex binary options is the North American Derivatives Exchange (Nadex), which offer options for 11 currency pairs. Nadex offers intraday, daily, and weekly expiration. At Nadex, the binary outcome is zero or $100.00. The Nadex website offers examples and a step-by-step guide. Nadex charges a transaction fee of $0.90 per lot (capped at $9.00) and a settlement fee (also $0.90 and capped at $9.00). Nadex also offers a Forex “bull spread” where the trader selects a range instead of a single number. Unfortunately, Nadex only allows opening a trading account to residents of a limited number of countries. Even if you are not a resident of one of the allowed country, you may want to look at the Nadex platform anyway because it is very well-designed and the pricing/outcomes are especially clear. For every trade, Nadex automatically shows the maximum profit and loss.
Binary options took off faster in Forex than in other markets and in the first few years, nearly 100 platforms sprang up. As might be expected, some of them were scams that simply stole the customers’ funds. In spring 2012, the Cyprus Securities and Exchange Commission required registration within six months, the first European country to require registration. Since then, CySEC has issued public warnings against specific Forex binary platforms. Malta was next, transferring oversight from the Lottery and Gaming Authority to the Financial Services Authority (transferring binary options from the domain of gambling to the financial derivative instruments).
You can see advertisements and come-ons all over the internet for binary options, of which some of the more educational ones are to be found on YouTube.
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