Binary Options 101

Investing & Retiring, Options

A new type of investment has recently emerged that has piqued the curiosity of options investors. Commonly referred to as binary options, this investment is an options contract in which the payout is based on the correct or incorrect answer of a simple yes/no proposition. Binary options are also sometimes called all-or-nothing options or Fixed Return Options (FROs).

A Simple Concept

While the names might sound fancy, the concept behind binary options is fairly simple. You invest a fixed amount of money based on whether you believe the price of a security (usually a publicly traded stock) will be higher or lower than a certain strike price at an exact time on a specific day.

For example, you could purchase a binary option for $100 wagering that the share price of XYZ Company will be higher than $25 at 3 p.m. tomorrow. If the share price is $26 come 3 o’clock tomorrow afternoon, your option is automatically exercised “in the money” and you will receive the agreed-upon return, which can be as high as 50 percent or more. However, if the share price is $24, your option is exercised “out of the money” and you will likely lose most or even all of your investment.

Binary options can also be purchased that expire in as little as 5 or 10 minutes. This harkens back memories of the day-trading investment craze that was popular back in the late 1990s.

Most binary options are traded via online trading platforms. Some of these platforms are subject to oversight by the U.S. Securities and Exchange Commission, but many are not. As a result, there have been an increasing number of complaints to the SEC and other regulatory agencies about binary option fraud.

Therefore, you should carefully investigate the trading platform before investing any money in binary options. Call the company and ask a live human being a few questions, including the company’s physical address. In addition, do some online research to find out what other investors are saying about the platform.

Is It Just Gambling?

Some critics of binary options argue that they are really nothing more than a new type of online gambling as investing in them does not require doing research in order to buy companies you think will be a good long-term investment. Rather, it is just guessing whether a company’s stock price will be higher or lower than an arbitrary strike price at some point in the near future.

It is also worth noting that the risk-reward equation of binary options is heavily tilted toward the trading platform, not the investor. This “house” advantage furthers the comparison to casino gambling. For example, while a 50 percent return on your investment might sound great, the flip side of the coin is that you could just as easily lose 100 percent of your money.

So are binary options a reasonable investment option for you? The best advice is to proceed with extreme caution — ideally consulting with a trusted investment advisor first— and not to invest too much money. How much money is too much? Let’s just say it’s more than you can afford to lose.

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