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Options Trading Explained

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  • Options Trading Explained

    The words 'binary option trading' are becoming more prevalent in the trading world. Some benefit is being derived from the current turbulent economic situation. Fluctuations in currencies, commodities and the like, have created an opportunity for profiting off these changes. Hence binary option trading has escalated in use and is a popular method of profiting for many investors.

    So what exactly is a binary option? A binary option is a contract, where a buyer has the right, but not the obligation, to buy an underlying asset at a set price within a specified time frame. This sentence is better explained when the different elements are each broken down:

    Underlying asset - this is the item which the option derives its value from. Examples of assets in option trading are commodities (such as Oil), indices (such as the Dow Jones), currency pairs (such as USD/EUR) and stocks (such as Microsoft).

    Set price - this is the price barrier, that the option needs to be above or below, for the option trade to expire in-the-money. This is fixed at the time of the contract and is known as the strike price.

    Specified time frame - or in the case of option trading it is known as the expiry time. This dictates the time at which the option will expire. A buyer can select from the end of the hour, day, week or month.

    It's important to note that in option trading, the buyer is not trading the asset itself, rather he's trading the right to buy the contract. This greatly affects the way an investor behaves and it generates different opportunities in the trading world.

    So, you've selected your asset, the price has been set and the expiry time chosen. What next? Now it's the crunch time - will the asset go up or down in price. It's your choice. If you think the asset will go up in price then buy a Call option. This means that if the price of the asset is above the strike price at the expiry time then you will be in-the-money. If you think the asset will go down in price then buy a Put option. This means that if the price of the asset is lower than the strike price at the expiry time then you will be in-the-money.

    If you are trading options on the anyoption(TM) platform then the return rates from your option will be a 65%-71% payout if the option expires in-the-money, and a 15% refund is paid out if the option expires out-of-the-money. If the option expires at-the-money i.e. at exactly the same price as the strike price, then you will receive 100% of your investment back.

    The best way to explain option trading is through an example:

    You decide that the price of Gold will soon rise and would like to profit from it. So, you place $1,000 in a Call option, expiring at the end of the week with a return rate of 71%. The strike price is set at 73.890. The price of gold fluctuates throughout the week, and depending on the price at the expiry time, there are 3 possible outcomes:

    1)The option expires at 73.891. Since this is above the strike price, the option expires in-the-money and the buyer receives a payout of $1,710.

    2)The option expires at 73.889. Since this is below the strike price, the option expires out-of-the-money and the buyer receives a 15% payback of his investment i.e. $150 (this is available when trading on the anyoption(TM) platform).

    3)The option expires at 73.890 exactly and the buyer receives his $1,000 back in full.

    To explain this further, when trading an option in situation no.1, the option is said to be in-the-money because the buyer theoretically has the right to buy the stock at a price which is lower than the price he would pay if he bought the asset in the current market.

    If the option had instead been a Put option and situation 1 occurred, then the option would have expired out-of-the-money because the buyer would have sold his option at a price lower than the market price.


    Article Source: http://EzineArticles.com/3627532
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