How do I trade Binary Options?

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Binary Basics
Binaries and Options

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Binary Basics

What is a Binary Option Contract?

A binary option contract enables you to profit from market price movements in an all-or-nothing fashion. BUY if you believe the market price will rise will occur to get the full value of the contract. SELL if you think the opposite will occur in order to get the full value of the contract.

Binary options are derivative contracts. The value of a binary option is based on, or derived from a future, commodity, or any other item or event that can be measured.

The examples below explain how binary option prices behave for underlying products that have prices. These prices are the result of the underlying product, such as crude oil, being traded throughout the day. Event binary options, such as who will win the presidential election in 2008, do not have as reliable an underlying price. These types of binary options can be priced based on poll data, but that is provided infrequently and is not as reliable as prices created from market trading.

How are Binary Options Priced?

A binary option on the HedgeStreet Exchange trades between $0 and $100, and the price the binary option trades at can be best thought of as representing the probability that the price of the underlying product will move up.

It is important to remember there are two prices in play. The price of the underlying product and that of the binary option. The binary option price is based on the price movement of the underlying product

Higher prices mean a higher probability that the strike, or target, price of the underlying product will be met. Lower prices mean a lower probability of the strike price being met. If the contract is trading right at the underlying market price, it could go either way - representing a probability of 50%.

Buying Binaries

When you BUY a binary option contract you are taking the position that the price of the underlying product will move up, which will cause the price of the binary option contract to rise.

For example, let's take a daily contract of Oil > $70, which pays $100 to Buyers if Crude Oil closes over $70, and $100 to Sellers if Crude Oil closes at $70 or below.

It's 8:30 AM ET, and the market has been trading for 30 minutes. Crude Oil is trading at $69, but you think it will bounce up from yesterday's profit taking activity.

Since Crude Oil is trading below the Strike Price of $70, the market is asking $20 for the contract, representing a probability of 20%.

You decide to Buy 10 contracts at $20 for $200.

At 11:00 AM ET, Crude Oil has moved up to $70, and the market is now asking $50 for the contract, representing a probability of 50%. It could go either way at this point. You could sell the contract right now for a nifty profit, or wait to see if Crude Oil moves higher yet.

At 2:00 PM ET, Crude Oil has moved up to $71, and the market is now asking $90 for the contract, representing a probability of 90%. It looks pretty likely that Crude Oil will close above $70. Again, you could sell the contract right now at $90 and make a profit, or wait 30 minutes until the market closes to collect the full $100 per contract.

Crude Oil closes that day at $70.75, the contract settles that evening, and your account is credited with $1000 ($100 for each contract), less any settlement fees.

Selling Binary Options

When you SELL a binary option contract you are taking the position that a upward price movement will not occur. You don't have to own a contract to sell it; you are simply taking a position against a Buyer.

For example, let's take a daily contract of Crude Oil > $70, which pays $100 to Buyers if Crude Oil closes over $70. That money will have to come from the Seller if the event occurs. But if the event does not occur, i.e. Oil is not >$70 at expiration, the Seller pays nothing to the Buyer AND gets $100, the nominal value of the Binary.

It's 9:30 AM ET, and the market has been trading for 30 minutes. Crude Oil is trading at $71, but you think it will fall from the previous days rise.

Since Crude Oil is trading above the Strike Price of $70, the market is bidding $80 for the contract, representing a probability of 80% (from the Seller perspective - the probability is 20%).

You decide to Sell 10 contracts at $80 for $800. The Buyer pays the $800. That money will be yours if you are right, but meantime, since HedgeStreet needs to guarantee the final payment of $1000 (10 contracts x $100), you the Seller will put up the remainder $20 per contract, or $200. At expiration, if you win, you get $1000 for a net gain of $800; if you lose, $1000 will be paid to the Buyer, and your loss will be $200.

At 11:00 AM ET, Crude Oil has moved down to $70, and the market is now bidding $50 for the contract, representing a probability of 50%. It could go either way at this point. You could Buy the contract right now, closing your position, for a nifty profit of $30 per contract , or wait to see if Crude Oil moves lower still.

At 2:00 PM ET, Crude Oil has moved up to $69, and the market is now bidding $10 for the contract, representing a probability of 10% (from the Seller perspective - the probability is 90%).

It looks pretty unlikely that Crude Oil will close above $70. Again, you could Buy the contract right now for a profit, or wait 30 minutes until the market closes to collect the full $100 per contract.

Crude Oil closes that day at $69.25, the contract settles that evening, and your account is credited with $1000 ($100 for each contract).

Understanding Probability and Opportunity

Because binary options trade at the probability of their outcome and trade between $0 and $100, Binaries offer unique opportunities. It's possible to create high upside and strong potential returns with little cash. It's also possible to take advantage of high probability, likely pricing scenarios, as long as you're willing to commit the cash for the instance that the unlikely happens.

* The probability for selling is from the Seller's perspective, which is the opposite of the Buyer's perspective, or 100% less the Buyer's probability

Understanding Charts

Charts show the relationship between the contract price and the underlying market price. The green shaded area shows the price of the underlying market (see the price scale on the left side). The blue line shows the price of the contract itself (see the price scale on the right side). The prices used for contracts are the average, or mid-market, of the bid-ask prices. Use the charts to understand the sensitivity of price movements in the underlying market to the contract prices.

What contract is right for me?

Contracts are grouped together in chains so that you can choose contracts that are appropriate for the opportunities you want to take advantage of.