Comparison of Binary and Vanilla Options

When it comes to options trading, simultaneous actions can affect every single node of a financial market. Buys and sells affect product volume, volatility, and price. Together with the events in the real world, they impact the global market of various resources, organizations, countries, and currencies.

Aside from stocks, bonds, and mutual funds, options are securities that open doors to knowledgeable investors. When versatile traders take advantage of the power of options, they are able to adapt to market changes and establish their position in it. Depending on the type of trades and traders, options may be as speculative or as conventional as they come. This means that traders can act on anything, from holding a position in a decline to aggressively following the movement of an index.

Just like any business, however, options will always involve risks. These complex structures will always cost traders some considerable amount at some point. Disclaimers on the risks of options are found in almost any agreement, and some traditional players may even advise against them unless a substantial risk capital is on hand. But even intentionally ignoring this security can pose substantial risk if a trade that is not made turns out to be profitable. With this in mind, traders keep on studying the mechanics of the market to keep on perfecting their strategies.

What Are Options?

Options are a right to buy or sell an underlying asset in a specified period. Many kinds of payouts are seen depending on the type of option. This trait lets investors speculate from different perspectives. Many may be used to long calls, but some may find good positions in short puts. Whatever trade style traders might adopt, options are exactly what they are called – options for the trader.

Options are a binding contract that has its own defined terms and conditions. Technically, an option is something that is paid in hopes of future returns, whether financial or further options. This means that in everyday transactions, options are all around us. To represent them in extreme ends of their application spectrum, two ideas may fork from a single situation: first, despite its cost, will you get a certain brand of toilet paper just because it’s more environment-friendly? And second, how does the paper industry’s reaction to the environmental constraints on their products affect the price of the commodity?

The complexities that arise from options abound. It’s a good thing that some instruments seem to be simplified to mask the underlying complications of the market and to provide the convenience of tools that can help determine the right conditions for profit. These simple instruments are binary options and vanilla options.

What Are Binary Options?

From the term “binary”, meaning “in two’s”, binary options indeed let traders speculate from the only two things that can happen to a price of an underlying asset–go up or go down–the third being a no-change. These options are derivative instruments in the market, which means that they are taken from underlying assets sold in contracts depending on the directionality of the asset. By combining the two concepts, the dual directionality of a trade is taken for its simplicity and provided to traders as a form of trading the market.

Traders can then purchase options such as CALL or HIGH, when they think that the closing price will be higher than the price at the time when the purchase was made; PUT or LOW, when they think that the closing price will be lower; or TOUCH, when they think that the price will reach a certain level in a certain period, among other options.

Binary options cover an array of financial securities such as stocks, Forex, indices, and commodities. If used correctly, they can be very rewarding. They can deliver a fixed return on every trade that is made, depending on whether it ended “in-the-money” (a correct bet), “out-of-the-money” (an incorrect bet), or a “tie” (a no-change). These options are often referred to as digital options because they are derivatives of the market in popular online trading platforms. In light of the spread of Internet connectivity, binary options are one of the fastest growing financial trading products in the world. Their simplicity, together with the obvious levels of risk and certainty in every trade, makes them an attractive trading tool for many financial investors.

What Are Vanilla Options?

Vanilla options, on the other hand, take their name from the plainness of the flavor. Like a normal vanilla ice cream that is stripped off of any chocolate or sprinkles, a vanilla option is normal call or put option that is removed of special features. Vanilla options only come in four types: the long call, the long put, the short call, and the short put. They provide traders with considerable leverage, especially experienced ones who know how to use leverage.

Vanilla options are simplified from many different options such as the Bermudan option, the Asian option, the capped-style option, the compound option, the Canary option and other types of options. Computationally, the vanilla option simply pays an investor the difference between the price of an underlying asset during expiration and the strike price of the option. The strike price is the price in which the buyer and seller of the option agree to trade the asset.

Whereas vanilla options may be too complicated for the novice trader, they provide a wide variety of option trading strategies by using market volatility and time decay.

Differences Between Binary Options and Vanilla Options

Below is a summary that discusses the differences between binary and vanilla options.

*These aspects are not defining differences rather common or usual differences. There are binary options that can be sold before expiry, and there are vanilla options that cannot be sold before the end of the trading period. Similarly, some binary options have a dynamic expiration that can be set to a day, year, or even longer. There are also vanilla options that can be set to expire in hours.

As we can see from the table, despite both options being very simple, they still have their differences. Binary options are for those traders who can rely on the further simplicity of just riding on the asset price to trade, whereas vanilla options provide the simplicity of not having the complex features that are found in exotic options. A good thing is that nowadays, some binary option brokers begin to offer classic vanilla options to their traders as an additional service. An example of such a broker is IQ Option.

In summary, the similarity between binary options and vanilla options is simplicity, and their differences are discussed above. Whatever option you choose, sound understanding of the market you are trading in is important to reduce risk and increase profitability. Let BinaryTrading.com provide you with more tips to help you make informed decisions.