Binary options for Dummies

Discussion in 'Options' started by harrybear, Jul 28, 2008.

  1. Binary options are good for beginners that want to get their feet wet, without worrying too much about all the jargon used in trading stocks. With binary options you either win or lose – there is no in between. The basic concept is that you buy a contract, either in the buy or sell mode and if the stock does as you predict you will receive money and if you were wrong, you lose it all.

    Of course, this can still be quite confusing. Binary options are not available with each and every stock out there. A matter of fact, it can be hard to find the ones that offer this option.

    The CBOE lists two stocks with binary options - VIX and SPX. The American Stock Exchange lists stocks with binary option as FRO and include Apple, Inc (AAPL), Cisco Systems, Inc (CSCO), Citigroup Inc (C), DIAMONDS (DIA), General Electric (GE), Goldman Sachs (GS), Google Inc CL.A (GOOG), Home Depot (HD), IBM (IBM), Intel (INTC), iShares MSCI Emerging Markets (EEM), iShares Russell 2000 Index Fund (IWM), JP Morgan Chase (JPM), Microsoft CORP (MSFT), Oil Service HOLDRS (OIH), PowerShares QQQ (QQQQ), SPDR S&P 500 (SPY), Select Sector SPDR-Energy (XLE), Select Sector SPDR-Financial (XLF) and Wachovia Corp (WB). Every stock exchange has their own binary options, so you will have to learn which ones are available with this type of option or listed as FRO’s.

    Now, to explain the concept. Binary options give investors a wide variety of trading options in that some are short-term trades while others may be quarterly since they are based on the date of expiration. You as a binary option trader will choose the stock that you wish to buy or sell by if you believe the price will go up or down on the date of expiration. If you think the market price is going to be higher then you buy. If you believe the market price will go down then you sell. If you choose correctly, then you receive payoff on each contract you had on that stock.

    Normally, the price you will receive is a fixed amount, such as $100. This means you will receive $100 for each correct contract. If you buy and spend $25 and the stock rises or are equal to the strike price on expiration, you will receive $100 for each contract. However, if you are not correct you will lose your investment all together.

    Metals and energy can also be bought and sold with binary options and be watched through the New York Mercantile Exchange. With the economy the way it has been heading, many investors are buying and selling foreign currency with the hopes of making a quick buck while others are looking to natural gas or crude oil.

    Example of buying a stock with binary options

    Light Sweet Crude Oil (CL)
    The strike price for buying (calls) is at 20000
    The strike price for selling (puts) is at 8000

    Looking at the market and the strike prices you can make an educated decision in which way you believe the stock will go. Let’s say you buy. The last strike price for calls was at 15000 and now it is at 20000. When you buy in you are saying the price of light sweet crude oil will be at 2000 or more on the date of expiration. If you are correct, you will then receive the set amount of money, usually $100, per contract.

    Example of selling a stock with binary options

    If you put on light sweet crude oil, believing the strike price of 8000 will be that or less then you will receive $100 per contract if the set amount is such.

    However, in both scenarios if you are incorrect and the strike price goes down with a call or up with a put then you will lose all money invested.

    Example of buying or selling a stock with binary options long term

    You can also call and put with stocks that do not have an expiration, except quarterly. This allows you a few more options. You can always change your mind, however, you will only receive the money you put into the stock.

    If you have a contract for Gold in the amount of $80 but now you do not believe the price will be the same or more, you have the option of selling. Of course, you will sell at a loss, but you will not lose your entire $80.

    However, if you leave it the same and you were correct in your speculation, you will receive the set amount of money per contract.

    You need to watch the binary option price the stock is selling at. This can be a great way to make an educated decision if the stock with rise or plummet on the expiration dates.