Types of Binary Options

Binary options are trades with a fixed risk and reward.  When you win a binary trade, you receive either a fixed amount of cash or a fixed amount of an underlying financial instrument.  While this is true of all binary options, there are a number of variations on this theme, all of which have different conditions.  What are the basic types of binary options you’re likely to encounter as you start learning how to trade?

Types of Binary Payouts

There are different ways you can categorize binary options; one way to do so is according to payout.  There are two ways you can receive your payment: cash or an underlying financial instrument.  “Cash or nothing” is the name of the first type of payout, while “asset or nothing” is the name of the second kind.  With these types of options, if you lose your trade, you “receive nothing.”  When you see this phrase, however, don’t make the mistake of taking it too literally—it should read that you “receive nothing and forfeit your investment.”

American vs. European Style Binary Options

You may also choose to classify binary options into American- and European-style trades.  With the American-style trades, options may be exercised immediately once the asset reaches the predetermined strike price.  So while the binary trade will still have a maturity date, you don’t have to wait for the asset to reach the strike price at the maturity period—you win as long as it does so before or at the expiration time.  European-style trades on the other hand do not allow you to profit unless the asset hits the strike price (or passes it in the direction you wagered) at the proper moment; if the asset hits the strike price before the maturity period is up but the trade reverses on you when the period expires, you still lose.

Common Types of Binary Options

Four other types of trades you need to learn about are referred to as One Touch, No Touch, Double One Touch, and Double No Touch.  “Touch” in these names refers to the underlying asset touching the strike price, which you may also hear referred to as a “trigger.”  As you might deduce, the names refer to the conditions under which you might win a binary options trade.

One Touch and No Touch

One Touch is the most basic of all these types of trades—it’s exactly what we’ve been talking about to this point.  If the asset touches the strike price value a single time within the specified window, you win your trade.  When you enter a No Touch trade, you’re wagering the exact opposite.  Instead of betting that the asset will touch a certain strike price, you’re wagering that it will not touch a certain strike price.  If within the specified time window price does not touch the price you indicated, you win the trade.

This might make you think, “Why not just pick a strike price that’s ridiculously far away from the current price and which is incredibly unlikely to ever be reached?”  The reason this won’t work is that the payoff will be ridiculously low for such a bet, and will not be enough to make your trade worthwhile—you still have to pay the spread, and it won’t make up for it.

Double One Touch and Double No Touch

Double One Touch you can think of as a trade where you’re hedging your bets.  You choose two different strike prices in this scenario.  If either strike price is reached during the expiration period, you win your trade.  You might use this method when you expect price to break out but you aren’t sure in which direction.  You could place a strike price on either side of the current price and see which way it goes.  If price consolidates instead of hitting one of your targets, then you will lose your trade.  If you place your strike prices ridiculously close to the current price, your payoff will be too small to justify your trade—again, there’s no cheating the system.  No broker is going to pay you for making a bet on something which is more or less inevitable.

Double No Touch is another type of trade in which you choose two strike prices, only this time you’re betting that price will touch neither of the two values you set.  If either value is touched during the specified time period, you lose your trade.  If neither strike price is touched, then you win your trade.  When would you choose a binary trade like this?  One application might be during a time period when you believe that price is consolidating and isn’t going to be trending much above or below its current value.  Traditionally it’s tough for traders to profit during consolidation (which tends to be a lot of what goes on in any market), but this is one way you could potentially do it.

Now you should feel more familiar with the types of binary options that are out there.  This is by no means an exhaustive list, however, since there are many other ways in which it is possible to vary the conditions under which you trade.  For example, the simplest type of trade might be one in which you double your investment if you win a trade or lose 100 percent of it if you don’t.  But you could also enter into a trade where you win or lose a certain percentage of your investment.

Any variation on the type of binary option or the way in which you manage your money demands to be tested thoroughly before you start trading live with your own money.  So when you’re backtesting and demo testing new methods of trading, try out some different types of binary trades as well, and understand that every time you vary the conditions under which you trade, you will have an impact on whether or not you’re going to be profitable—even using the same method.  So different types of trades call for different methodologies.  You may need to tweak your system for every type of trade you make, even if one method has the potential to work for multiple types of binary options.

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