Options trading can be confusing. There are entire books written about how to value options. There are university courses that explain options pricing to students. There are formulas that must be used to calculate the price of an option based on whether it’s a call or put option, what the price of the underlying is doing, volatility, and time remaining until expiration, which is called “time premium.”
An option is conceptually simple, however. It is a contract that guys the buyer the right (but not the obligation) to buy or sell a certain number of shares of a stock at a certain price as of a certain time. Similarly, it gives the seller the obligation to buy or sell a certain number of shares of a stock at a certain price at a certain time. The calculations mentioned above come into play in determining the value of the options when they are bought and sold. Fortunately, they are all handled behind the scenes by the broker, but a rough understanding of them is still needed by the trader to avoid surprises and unexpected losses.
So with all this potential confusion, why do people trade options?
Easy! Options give you access to more leverage than you would have otherwise, and let you employ strategies that you could not do by simply buying and selling just the underlying (for example, one strategy is called a “straddle,” which lets you profit if price goes up or down within a certain time, but not if it stays relatively unchanged).
There is a more simple type of option, however, called a binary option. Binary options are named as such because there are only two possible outcomes: a win or a loss. With binary options, all possible outcomes are known beforehand. Unlike with standard options where the value is constantly changing based on price of the underlying, volatility, and time left to expiration, with binary options you know exactly how much you stand to make before you enter the trade.
You pick a price as of a specific time (for example, tomorrow at noon), and whether you think at that time price will be above or below a specific point, and buy the appropriate option. You will know ahead of time how much you stand to gain if you are right. For example, your time and price might have a 75% payout, which means if you go in with $100, you stand to win $175.
When the option expires, it doesn’t matter how far past your chosen price you are; you still get paid the same fixed amount (quite the opposite of standard options!).
And since the possible outcomes (win or loss) are known beforehand, there are never any surprises, nor is it possible to end up in a situation where you owe more money than you initially invested. For this reason, binary options are also safer than regular options.
