Binary Options Trading Strategy

Options are financial instruments that help investors hedge their positions and help traders benefit from price movements. Traders can deploy several option trading strategies to make a profit in various market conditions. One of these is binary options. In this blog, we will cover the binary options trading strategy and its uses.

What are Binary Options?

Before using a binary options trading strategy, it is important to understand binary options and how they differ from plain vanilla options.

Binary options are financial contracts used to speculate on the underlying asset's price. The contract has a fixed payoff if the prediction is correct. If the prediction goes wrong, the trader will lose the premium he paid for the option. This gives binary options an ‘all-or-nothing’ nature. The expiry for these contracts ranges from minutes to several months.

Trading Binary Options

Let us try to understand how a binary option trading strategy works with the help of an example.

The first step of trading binary options is to select an underlying asset such as a stock, currency, or commodity.

For example, the trader picked stock ABC because he believes that the price of the stock will rise from Rs.50 to Rs.80

To speculate on this price move, the trader purchases a binary option for the strike price of 70 which was trading at a premium of Rs.60. The binary option has a fixed pay-out of 75%.

With trading binary options, there are two possible outcomes:

If ABC’s price remains below or at the strike price of Rs 70 the binary option will expire worthless, resulting in a loss of the premium paid, i.e., Rs 60.

If the price of ABC rises above Rs 70, the binary option will make a profit resulting in a fixed pay-out of 75%, i.e., a profit of Rs 45.

Thus, we understand that binary options can help traders speculate on the price of an asset. However, if the prediction is inaccurate, the trade will result in a complete loss.

How are Binary Options Different from Vanilla Options?

Vanilla options refer to the regular options that traders use for option trading strategies. These options have an expiry date, strike price, and a varying premium.

The main difference between binary options and vanilla options is that binary options have a fixed pay-out whereas the premium of vanilla options is dependent on how significant the price movement is and the strike price of the option. Further, the flexibility in vanilla options is higher as a trader can choose a suitable expiry period. Vanilla options are also less risky compared to binary options.

Benefits of Binary Options

Binary options can prove to be beneficial to traders in various ways.

Ease of Use

The concept of binary options is simple and easy to grasp. It provides traders with an accessible way to speculate on the price movements of an asset.

Predetermined Risk and Reward

Binary options have a predetermined risk and reward. The risk of a binary option is the premium that a trader pays while the reward is the fixed pay-out. As a result, a trader can effectively make financial decisions and manage risk.

Suitability for Short Term

Binary options are a great instrument for short-term speculative trades. Certain binary options have expiry periods that range from minutes to hours allowing traders to capitalise on quick price fluctuations in the asset.

Asset Choices

Binary options can be used on a diverse range of assets such as stocks, commodities, indices, and currencies. Traders can pick an asset class that is suitable for them and use binary options to trade them.

Capital Requirement

Binary options have a low capital requirement which reduces the barriers to entry. The lesser capital requirement makes binary options beginner-friendly and allows traders to trade without putting in significant funds.

Global Market

Along with access to various assets, binary options also allow traders to access markets across the globe. As a result, traders can also use binary options to benefit from arbitrage opportunities.

Objective Nature

Emotions are one of the key challenges while trading. Since binary options have a fixed risk and reward, the magnitude of price changes does not impact traders. The trade will either be profitable or end in a loss.

Limitations of Binary Options

Binary options also have a few cons that traders should be aware of:

  •       Binary options are unregulated in several markets. The lack of regulation can lead to scams and unfair practices.
  •       The speculative nature of binary options can result in significant losses.
  •       Trading in binary options may also lead to high brokerage charges and other costs.

Are Binary Options Legal in India?

The Reserve Bank of India (RBI) has prohibited the online trading of binary options. Due to the high risk that binary options carry, they are restricted to certain securities and exchanges globally. Binary options are not regulated in several countries including India which increases the risks of trading in these instruments. 

Conclusion

Binary options trading strategies allow traders to speculate and benefit from the price movements of an asset easily. However, binary options can tend to be risky due to their speculative nature. Therefore, it is of utmost importance for traders to conduct thorough research and effectively manage risk.

FAQs

Is binary option trading legal in India?

The Reserve Bank of India (RBI) has prohibited the trading of binary options online in India.

What are the expiry periods of binary options?

The expiry periods of binary options range from several seconds to a few months.

Is binary option trading risky?

Binary options are speculative in nature. Although the risk is predefined, the nature of the contracts makes binary options risky.

Can you trade binary options in forex?

Binary options can be used to trade numerous assets such as stocks, commodities, and currencies.

What is the maximum loss of binary options?

The maximum loss of binary options is limited to the premium paid for the binary option.

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