Knowledge is the key
Experts generally agree that trading in binary options is one of the most convenient ways to ensure success in this sector. However, just as in the cases of dealing with any other financial instrument, users need to be familiar with all the nitty-gritty related to binary options in order to reap benefits from these tools. In this article, we would take a close look at some of the common terminologies pertaining to binary options.
What is an option?
At the very outset, traders should be aware of what an option actually means in the realm of financial markets. Formally put, an option is the right to buy (or sell) an underlying asset, at a pre-specified strike price, on or before a certain pre-determined maturity date. The option holder, however, has no obligation to execute this right and is solely guided by the price movements of the underlying asset.
The Other Important Binary Option Trading Terms
- The ‘underlying asset’ is one of the most important components of any binary option contract. The price movements of this asset are taken as reference for determining whether an option would be executed or not.
- The pre-determined price at which the underlying asset is agreed to be traded on the date of maturity of the binary option is called the ‘strike price’. When the option matures, the market price of the asset is compared with this strike price to determine payoffs. It is also popularly known as the expiry price.
- A ‘call’ option is that variety of binary option that provides the holder the right to purchase the underlying asset. Such options are bought when investors speculate that the market price of the asset is likely to rise in future. Conversely, a ‘put’ option gives the right to sell the underlying asset, and they are held when the price of the latter is expected to go down.
- A binary option is said to be ‘in-the-money’, when actual price movements match the investors’ speculations. Options are executed only when they are ‘in-the-money’. For example, a call option is said to be ‘in-the-money’, when the market price of the asset on the date of maturity is above the strike price. The reverse is true for put options.
- By the same token, binary options are termed ‘out-of-the-money’, when the prices of the reference assets move contrary to the speculation of the traders. Extending the earlier example, call options are ‘out-of-the-money’ when the prevailing price of the asset goes below the strike price.
- As is the case for any other financial dealings, binary option trading also requires the drawing up of an official contract. A ‘binary option contract’ has to incorporate the date of maturity, the strike price, the nature of the underlying asset and other relevant information.
- Binary options are generally traded ‘over-the-counter’. This means, there is no involvement of any financial exchanges in the buying and selling of these options. Exchange-traded binary options are available as well. Incidentally, binary options are also known as ‘digital options’.
Provided that the price speculations of investors prove to be correct, handsome profits can be gained from binary options trading. Given the dynamic nature of these instruments, traders need to be well-versed with all the popular terms used in relation to binary options.
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