The Top Three Reasons Novice and Savvy Traders Alike are Using Binary Options

The Top Three Reasons Novice and Savvy Traders Alike are Using Binary Options

By Craig Walters of WallStMavens.Com for Nadex

Image: Traders have access to Nadex binary options contracts for metals including gold, silver, and copper.

There is a financial instrument that is capturing the interest of people around the world, but according to search-engine trend data, has not yet fully grabbed the US trading public…

It’s not ordinary equities – interest in them is fairly flat despite a raging bull market. It’s not conventional stock options as search interest in them has been relatively flat for years, too. Even structured products – instruments that are both relatively new and somewhat controversial since 2007/2008 – are not on an upward trend in global search.

But this particular instrument, with its search interest trend pictured below, is gaining worldwide interest:

Source: Google Trends

Don’t know what it is?

It’s the Binary Option. It’s the simpler version of conventional options but with lower barriers to trading, and fewer investment variables to value and consider. And it would appear that it’s about to take US options trading by storm…

Background on Binaries

The binary option as we know it today, packaged for easy exchange trading, has only been around since 2008. The binary call option, in particular, was rolled out that summer on the Chicago Board Options Exchange (CBOE) to be followed by the binary put option a few months later. It was also around this time that the North American Derivatives Exchange, or Nadex, currently the most active binary option exchange designed for retail traders, was launched.

In those early years, some called binaries out-and-out gambling with little to do with real investing. Others called them “options for children” because of their limited outcomes and fixed-profit potential.

Putting all prejudices aside, binary options may very well be a large, positive step toward bringing options trading to a much wider audience.

1. Lower Hurdles: Enter Into Your First Contract Faster than Reading this Article

Typically, to buy a single binary option contract, traders need only to have the cash in their trading account to cover the maximum loss – should it occur. Since the maximum loss is equal to the option premium, the cash requirement is the cost of the contract. That’s a pretty reasonable and achievable hurdle. In most instances, there are no fees to open an account and most leaders in the binary options business do not require clients to maintain any specific account levels. Additionally, because trades are fully collateralized rather than traded on margin, the client is never at risk of losing more than the capital placed on a given trade.

An area where binary options greatly benefit the average individual trader is in their asset reach. In the not-too-distant past, currency and commodity trading was the domain of futures contracts which to this day have fluctuating margin requirements, particularly when trades move against the trader. Individuals establishing accounts for futures trading must expect to initially deposit several thousand dollars even before the first trade is placed. Options on futures have lowered the capital requirement hurdles somewhat for individuals interested in futures, but the fact that binaries exist on currencies, commodities, and indexes, with relatively low account requirements, makes them compelling alternatives.

2. Simplification: Removing a ‘Moving Part’ from the Options Trading Process

A conventional call option, for example, requires traders to consider, at the very least:

1. the future direction in value of the underlying asset
2. the magnitude of that value change
3. when those changes are likely to play out

A binary option completely strips out the magnitude factor from consideration. Why is that important? Doesn’t it limit the profit potential for the trader? Yes – a ceiling is knowingly placed on the profit from a binary contract. But that theoretically reduces the demands on valuing the underlying asset, and places the focus on direction and timing. Factors that create directional market changes, i.e. changes in interest rates, are often within the skillsets of those outside of the investment industry whereas asset valuation often is not.
For those traders who build their valuation skills, they can always choose to graduate to conventional options with their more open-ended potential.

3. Visibility on Both Upside and Downside

If individual investor affinity for fixed-income securities has taught capital markets anything, it’s that there is value in knowing precisely what your return will be. Principal-protected structured products have also proven popular as well for the same reason. Visibility on the return one can expect is paramount for both planning and peace of mind. And while binary options do not provide a guaranteed return, both the maximum profit and maximum loss of these contracts are known before the trade is ever made.

Craig Walters of WallStMavens.Com for Nadex

Futures, options and swaps trading involves risk and may not be appropriate for all investors.