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Basics of Put or Call Binary Options Trading
If you are new to trading online, then you will come across two common words in this industry and that is the put or call option. These are the most popular binary option trading words. Both these terms are related to primary asset price movement.
The put option is a term that will predict the price decline of the underlying asset and the call option will predict the increase in the price of the underlying asset. You will stand to make a profit only if your put or call prediction for the underlying asset is not above or below the strike price at the end of the expiration time and date.
Here is a list with the most trusted binary options brokers where you can start trading binary options with put or call actions:
Broker | Min. Deposit | Max Returns | User Rating | Review | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$250 | 89% | Read Review |
What happened to our option investment | |||
---|---|---|---|
May 1 | May 21 | Expiry Date | |
Stock Price | $67 | $78 | $62 |
Option Price | $3.15 | $8.25 | worthless |
Contract Value | $315 | $825 | $0 |
Paper Gain/Loss | $0 | $510 | -$315 |
The majority of the time, holders choose to take their profits by trading out (closing out) their position. This means that option holders sell their options in the market, and writers buy their positions back to close. Only about 10% of options are exercised, 60% are traded (closed) out, and 30% expire worthlessly.
Fluctuations in option prices can be explained by intrinsic value and extrinsic value, which is also known as time value. An option’s premium is the combination of its intrinsic value and time value. Intrinsic value is the in-the-money amount of an options contract, which, for a call option, is the amount above the strike price that the stock is trading. Time value represents the added value an investor has to pay for an option above the intrinsic value. This is the extrinsic value or time value. So, the price of the option in our example can be thought of as the following:
Premium = | Intrinsic Value + | Time Value |
$8.25 | $8.00 | $0.25 |
In real life, options almost always trade at some level above their intrinsic value, because the probability of an event occurring is never absolutely zero, even if it is highly unlikely.
Types of Options
American and European Options
American options can be exercised at any time between the date of purchase and the expiration date. European options are different from American options in that they can only be exercised at the end of their lives on their expiration date. The distinction between American and European options has nothing to do with geography, only with early exercise. Many options on stock indexes are of the European type. Because the right to exercise early has some value, an American option typically carries a higher premium than an otherwise identical European option. This is because the early exercise feature is desirable and commands a premium.
There are also exotic options, which are exotic because there might be a variation on the payoff profiles from the plain vanilla options. Or they can become totally different products all together with “optionality” embedded in them. For example, binary options have a simple payoff structure that is determined if the payoff event happens regardless of the degree. Other types of exotic options include knock-out, knock-in, barrier options, lookback options, Asian options, and Bermudan options. Again, exotic options are typically for professional derivatives traders.
Options Expiration & Liquidity
Options can also be categorized by their duration. Short-term options are those that expire generally within a year. Long-term options with expirations greater than a year are classified as long-term equity anticipation securities or LEAPs. LEAPS are identical to regular options, they just have longer durations.
Options can also be distinguished by when their expiration date falls. Sets of options now expire weekly on each Friday, at the end of the month, or even on a daily basis. Index and ETF options also sometimes offer quarterly expiries.
Reading Options Tables
More and more traders are finding option data through online sources. (For related reading, see “Best Online Stock Brokers for Options Trading 2020”) While each source has its own format for presenting the data, the key components generally include the following variables:
- Volume (VLM) simply tells you how many contracts of a particular option were traded during the latest session.
- The “bid” price is the latest price level at which a market participant wishes to buy a particular option.
- The “ask” price is the latest price offered by a market participant to sell a particular option.
- Implied Bid Volatility (IMPL BID VOL) can be thought of as the future uncertainty of price direction and speed. This value is calculated by an option-pricing model such as the Black-Scholes model and represents the level of expected future volatility based on the current price of the option.
- Open Interest (OPTN OP) number indicates the total number of contracts of a particular option that have been opened. Open interest decreases as open trades are closed.
- Delta can be thought of as a probability. For instance, a 30-delta option has roughly a 30% chance of expiring in-the-money.
- Gamma (GMM) is the speed the option is moving in or out-of-the-money. Gamma can also be thought of as the movement of the delta.
- Vega is a Greek value that indicates the amount by which the price of the option would be expected to change based on a one-point change in implied volatility.
- Theta is the Greek value that indicates how much value an option will lose with the passage of one day’s time.
- The “strike price” is the price at which the buyer of the option can buy or sell the underlying security if he/she chooses to exercise the option.
Buying at the bid and selling at the ask is how market makers make their living.
Long Calls/Puts
The simplest options position is a long call (or put) by itself. This position profits if the price of the underlying rises (falls), and your downside is limited to loss of the option premium spent. If you simultaneously buy a call and put option with the same strike and expiration, you’ve created a straddle.
This position pays off if the underlying price rises or falls dramatically; however, if the price remains relatively stable, you lose premium on both the call and the put. You would enter this strategy if you expect a large move in the stock but are not sure which direction.
Basically, you need the stock to have a move outside of a range. A similar strategy betting on an outsized move in the securities when you expect high volatility (uncertainty) is to buy a call and buy a put with different strikes and the same expiration—known as a strangle. A strangle requires larger price moves in either direction to profit but is also less expensive than a straddle. On the other hand, being short either a straddle or a strangle (selling both options) would profit from a market that doesn’t move much.
Below is an explanation of straddles from my Options for Beginners course:
Straddles Academy
And here’s a description of strangles:
How to use Straddle Strategies
Spreads & Combinations
Spreads use two or more options positions of the same class. They combine having a market opinion (speculation) with limiting losses (hedging). Spreads often limit potential upside as well. Yet these strategies can still be desirable since they usually cost less when compared to a single options leg. Vertical spreads involve selling one option to buy another. Generally, the second option is the same type and same expiration, but a different strike.
A bull call spread, or bull call vertical spread, is created by buying a call and simultaneously selling another call with a higher strike price and the same expiration. The spread is profitable if the underlying asset increases in price, but the upside is limited due to the short call strike. The benefit, however, is that selling the higher strike call reduces the cost of buying the lower one. Similarly, a bear put spread, or bear put vertical spread, involves buying a put and selling a second put with a lower strike and the same expiration. If you buy and sell options with different expirations, it is known as a calendar spread or time spread.
Spread
Combinations are trades constructed with both a call and a put. There is a special type of combination known as a “synthetic.” The point of a synthetic is to create an options position that behaves like an underlying asset, but without actually controlling the asset. Why not just buy the stock? Maybe some legal or regulatory reason restricts you from owning it. But you may be allowed to create a synthetic position using options.
Butterflies
A butterfly consists of options at three strikes, equally spaced apart, where all options are of the same type (either all calls or all puts) and have the same expiration. In a long butterfly, the middle strike option is sold and the outside strikes are bought in a ratio of 1:2:1 (buy one, sell two, buy one).
If this ratio does not hold, it is not a butterfly. The outside strikes are commonly referred to as the wings of the butterfly, and the inside strike as the body. The value of a butterfly can never fall below zero. Closely related to the butterfly is the condor – the difference is that the middle options are not at the same strike price.
Options Risks
Because options prices can be modeled mathematically with a model such as the Black-Scholes, many of the risks associated with options can also be modeled and understood. This particular feature of options actually makes them arguably less risky than other asset classes, or at least allows the risks associated with options to be understood and evaluated. Individual risks have been assigned Greek letter names, and are sometimes referred to simply as “the Greeks.”
Below is a very basic way to begin thinking about the concepts of Greeks:
Binary Call Option Explained
The binary options trader buys a basic binary call option if he is bullish on the underlying in the very near term. This basic binary call option is also known as the common “High-Low” binary call option.
By purchasing a basic binary call option, the trader is simply speculating that the price of the underlying asset will be higher than the current market price when the option expires, typically within next few minutes or several hours.
It is entirely up to the trader how much he wishes to invest with each purchase of the binary call option. The minimum and maximum he can put in with each call option varies across brokerages.
Moneyness
If the price of the underlying is above the strike price of the binary call option, the option expires in the money and the trader stands to receive a payout. Otherwise, the option expires out of the money and he loses his initial investment.
In the rare event where the price of the underlying asset is exactly the same as the strike price, the option expires at-the-money and the trader will simply get back his original investment.
Limited Profit
If the binary call option expires in the money, the trader receives a profit which is equal to the payout% multiplied by the initial investment.
Limited Risk
If the option expires out of the money, the trader loses his initial investment. This is also the maximum he can lose in this trade.
Binary Call Option Example
A binary options brokerage is offering 85% payout for the binary call option on EUR/USD which is currently trading at $1.30.
After tracking the price movement of EUR/USD for the past hour, the binary option trader believes that the price will rise over the next 5 minutes and decides to invest $100 to purchase a binary call option on EUR/USD expiring in the next 5 minutes.
If EUR/USD goes up to say $1.31 five minutes later, the investment pays off and the traders earns a profit of 85% of his initial investment, which is $85.
However, if the price of EUR/USD drops down to say $1.29 instead, the trader will have lost his initial investment of $100.
Note that it does not matter whether the price of EUR/USD skyrocketed up to $1.40 or flash crashed below $1.00, both the profit and loss will be fixed at $85 and $100 respectively.
Binary Put Option
If the binary options trader is bearish on the price, he or she can buy a binary put option instead.
Continue Reading.
What are the Main Types of Binary Options?
Learn how the One-Touch, No-Touch and Range/Boundary binary options differ from the common high-low viety and how to trade them. [Read on. ]
What Assets can be Traded using Binary Options?
Many of the most popular financial instruments such as currency pairs, equities and commodities are available to trade using binary options. . [Read on. ]
Binary Options: Trading or Gambling?
Is binary option a legitimate financial instrument or just another form of gambling. [Read on. ]
Binary Options & Trading Robots: A Perfect Match?
Unlike humans, robots have no emotion and do not need to rest, so they can make a lot more trades than humanly possible, combined with perfect consistency. [Read on. ]
Is Binary Options Trading a Scam?
Learn how you can get scammed when trading binary options if you are not careful. [Read on. ]
How to Select a Binary Options Broker?
With so many scam brokers out there, before you learn how to trade, one must know how to separate the wheat from the chaff and find a trustworthy binary options brokerage. [Read on. ]
Binary Options: Calculating Breakeven Win-Rate for a Given Payout
How often does my trades need to be successful in order to be consistently profitable in the long run when trading binary options. [Read on. ]
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Binarium
Top Binary Options Broker 2020!
Best Choice For Beginners and Middle-Leveled Traders!
Free Demo Account!
Free Trading Education!
Big Sign-Up Bonus! -