Over the course of the last decade online brokerages have brought an innovative financial derivative to retail traders. This derivative is called the binary option. Binary options let you profit of a simple up or down price movement of an underlying security, such as a stock index, a currency pair or a commodity, within a certain time frame. Binary options can be a great financial product to earn extra income on a regular basis, and are now offered by most online brokerages in the United States.
How Do Binary Options Work?
If you want to start generating trading profits using binary options, you need to first learn what are binary options, so that you know exactly how to trade this financial derivative successfully. If you are purchasing a binary option, you can either purchase a call or a put. A call would be a bet on the price of the underlying security to increase, while a put would be a bet on the underlying security to decrease, within a specified time frame. Binary option can have a range of time frames, with popular ones being ‘5 minute markets’, ‘1 hour markets’, ‘end of day close’ or ‘end of week’. It is entirely up to the trader and his or her strategy to decide which time horizons to trade.
Let’s look at an example trade. Say you want to bet on the price of the S&P500 to go up within the next hour. You would buy a call on the S&P500. The price of a binary option is always between $0 and $100, and your online brokerage will show you a two-way price on any binary option market. The two-way price will most likely look something like this: 48.00/52.00. The 48.00 is the bid price, at which you can sell the S&P500 and bet on a price decrease. While the 52.00 is the offer (or ask) price, at which you can buy the S&P500 and bet on a price increase. This is what we want to do in this example. So, say we place $10 per 1 unit on a price increase at 52.00, and the price does end up being in the green at the end of the one-hour investment horizon, we will make a $480 profit [$10 x (100-52)] on that trade. Adversely, if the price of the S&P500 had ended up lower, at the end of the investment horizon, then we would have lost $520 [$10 x (0-52)].
The difference between the bid and the offer price is how the brokerage makes money. And because you are ‘paying bid-offer’ your odds are not 50/50, but actually slightly skewed against you. Hence, it is important that you trade with a smart trading strategy in mind.
Binary Options Trading Strategy #1: Trading The Economic Data
Since you are placing short-term directional bets on where an underlying asset will go, you want to ideally place trades when there are strong short-term trends in the market. These can be most clearly observed after economic data announcements such as GDP numbers, U.S. non-farm payroll numbers, housing data, manufacturing P.M.I., etc. Underlying assets such as the S&P500, the EUR/USD and U.S. Treasuries tend to react sharply to better than expected or worse than expected U.S. economic data announcement. Therefore, these are great binary options markets to profit off, just after the data numbers have been released.
Binary Options Trading Strategy #2: Trading The News
Alternatively, you could trade binary option markets that show clear trends after certain news headlines. For example, any announcement from major oil suppliers, such as Saudi Arabia, about their oil supply will have sharp effects on the price of oil, and can lead to clear trends which can be used to benefit off, by buying oil binary options just after the news release.
