Binary options are a type of financial instrument that pays out a predetermined amount if the underlying market moves above or under the strike price within a certain time span.
In binary options, the greatest prospective loss is controlled and known ahead of time, which is a huge advantage over trading spot Forex.
From trading futures contracts to speculating on price action with binary options, forex traders can access the market without owning the currency.
Assume you’re purchasing EURUSD in the spot market. This effectively means you’re purchasing EUR while paying the trade with USD. When you sell EURGBP, you’re effectively selling EUR and buying GBP, implying that you anticipate the euro’s value will fall against the pound’s.
Components of a binary option contract
There are three key components in every binary option contract:
- The underlying market: this is the market you’ve chosen to invest in.
- The strike price: to place a trade, you must decide if the underlying market will be above or below the strike price.
- The time and date of termination of the contract: you can hold a binary option contract from a few minutes to about a week.
All the binary options in forex have two possible results:
- Settling at a set amount
- Settling at $0
The amount is determined by whether the principal currency of the binary option is trading upwards or downwards from the strike price at the time of the contract expiration.
Trading binary options in forex
Using the EURUSD currency pair as an example, here’s how to trade binary options contracts:
EURUSD > 1.1600 (3AM)
The deal has a 3 AM termination time. Simply put, this binary option asks if the EURUSD currency pair will be higher than 1.1600 at 3 AM.
If you believe it will be, you should purchase it. If you don’t believe it will be, you should sell. Let’s say you decide to buy in this situation.
There are two possibilities. First, the price is at or below 1.1600 at 3 AM, implying you won’t get paid this time but lose the money you put up to make the trade.
Instead, the compensation will go to the vendor. If there is one tick or more above 1.1600 at 3 AM, you’ll be paid $100.
Types of binary options in forex
1. Up/Down options: Traders buy a “call” option if they believe the market will close above the strike price when the contract expires, or a “put” option if they believe the market will close below the strike price at the termination of the contract. This type of binary option usually has lower payouts and expires within an hour or a day.
2. Touch options: In a touch option, a trader buys an option that pays out if the market price of the asset bought meets the stated target price at least once before the expiration date.
Touch trades are available at specific times of the day, and some brokers provide them on weekends, with bigger rewards (about 250 percent to 400 percent of your risk premium) than a standard Up/Down option trade.
3. Range option: Traders employ range options to predict whether an asset will stay within a given price range for a set period of time. This kind of option usually has the highest payouts of around 200%-750% and is best used when the volatility is low in the market.
Binary options Forex trading strategies
In forex, binary options trading methods are used to spot trends and place positive expectation trades.
Technical analysis helps traders estimate the possibilities of the market reaching, breaking, and finding support/resistance at a specific price.
Sentiment analysis might help you determine whether the market participants are greedy or risk-averse.
Binary options are a useful instrument in forex trading. However, such options also have disadvantages, including the limited reward potential: even when the price keeps going in the trader’s favor, the reward is predetermined.
Another disadvantage is that; binary option being a derivational product with a terminable lifespan (time to termination). The limited lifespan of the option position is another disadvantage, as there’s a specific time to contract expiration.
On the other hand, binary options have a number of aspects that make them very effective in the uncertain market environment. Firstly, the risk is limited. Second, volatility isn’t always needed to profit.
For the skilled forex trader, the benefits make binary forex options a viable option.