Binary options

All or nothing options

Binary options are a type of option where you try to predict the short-term movements of a share price, currency, index or commodity. They are relatively new in Australia and are a speculative, high risk product.

Here we explain what binary options are and the risks you need to know about before you consider trading them.

What is binary trading?

Binary options are also called 'all-or-nothing options', 'fixed return options' or 'digital options'. The payoff is either a fixed amount or nothing at all.

With a binary option, you are trying to predict whether the price of an asset, a commodity or index, will be trading above or below a specified price at a specified time in the future. For example, will the share price of a company be trading above its current price in one hour?

You can buy binary options on major market indices, foreign exchange rates, commodities and share prices. You can choose the expiry date, however, contract times are usually very short, from a few minutes or hours to a few months in the future.

Trading binary options may appear to be simple but picking the short-term movements of a share price, currency, index or commodity is extremely difficult, even for professionals.

Binary options are a high risk speculative investment which, unless you are following a market carefully, are really just a bet or gamble on an asset price movement.

Binary option payouts

Unlike other types of options, a binary option does not give the option holder the right to purchase or sell the underlying asset.

When a binary option reaches its expiry, the holder receives a fixed cash payout if they have picked the price movement correctly. This is usually a percentage of the cost of the binary option contract.

If you don't choose the price movement correctly, you lose your entire investment (what you paid for the option).

Types of binary options

Binary options can be based on various products including shares, forex (foreign exchange), economic events, commodities or market indexes.

There are two main types of binary options available, which include:

  • Once touch binaries - The underlying market or asset price will or won't touch, or reach, a specific level at some time at or before expiry
  • Digital binaries - The underlying market will or won't  finish higher or lower than a specific level at expiry

There are unlimited variations of these two types of binaries, including combinations with plain vanilla options. Many structured products contain binary type rules where the interest on a deposit pays for the binary for an event to occur or not to occur. For example, the price of XYZ share will remain between $10 and $20 for 3 months, or the price of XYZ share will not remain between $10 and $20 for 3 months.

While binary options seem simple, picking short-term price movements of markets or asset prices is extremely difficult.

Before you consider investing in binary options, it is very important that you understand how the type of binary option you are using works and how it is priced. You'll also need to be comfortable with the fact that you are risking all of the money you invest. 

Buying and selling binary options

Most binary option providers operate through online platforms. Make sure the binary option provider has an Australian financial services (AFS) licence or is authorised by an AFS licensee, regulated by ASIC. To see if a company holds an AFS licence, search ASIC's Professional registers.

Binary options are a financial product based on the underlying market or asset price moving in a certain way before the binary option expires. If the statement proves true, the binary option will settle at 100. If the statement proves false, the binary option will settle at 0.

Binary options are quoted as a two-way buy/sell price. If you agree with the binary statement you buy the binary option in anticipation of it settling at 100. If you disagree with the binary option statement you sell the binary, expecting it to settle at zero.

Until expiry, the binary option price will move between 0 and 100 depending on how likely the outcome is.

Once you acquire a binary option, there are no further decisions for you to make as to whether or not to exercise the binary option because binary options exercise automatically.

Don't send documents to unlicensed providers

Binary options traders must have an AFS licence. If you are setting up an account, make sure you are dealing with a licensed operator before you hand over copies of your personal identification documents, such as a driver's licence. Check operators are licensed on ASIC's professional registers.

Case study: Richard invests in binary options

Case Study RichardRichard saw an online video advertising binary options, that claimed he could make an 80% profit in just a few minutes.

Richard visited the company's website and saw that they offered binary options on the shares of some large, well-known companies. As Richard had a share portfolio and actively followed the share market, he thought he'd give it a go.

Richard paid $400 for a binary option contract that expired in an hour. He placed a 'call' option with a payoff of 70%, or $280, if the share price was trading above the current price of $1.50 at the expiry time.  An hour later the share price was trading at $1.48. Richard did not pick the price movement correctly and lost his $400, the cost of the contract.

He decided binary options were too risky for him and that he'd be better off focusing on his share portfolio.

Risks of binary options

Binary options are speculative, high risk products, where you can easily lose your entire investment. Once you buy a binary option contract you may not able to re-sell it before the expiry date.

Binary options often offer payouts that appear quite high, for example 50% to 80% of the money you invest, if you pick the correct price movement. However, if the price does not move in the direction you chose, you'll lose 100% of your investment.

You need to understand the implied probability (the true odds of an event occurring) from the binary price. The midpoint between the buy/sell prices is a good indicator of the expected probability of the binary settling at 100. A binary price of 10/14 indicates that the market expects there is only about a 12% probability of the binary settling at 100.

There may also be a risk that the binary options provider won't be able to fulfil its obligations to you if something goes wrong (counterparty risk). For example, if the provider became insolvent, you may be ranked as an unsecured creditor and have difficulty getting your money back. 

Warning about binary options trading apps

If you are looking to invest in binary options through a mobile app or using a mobile app for advice about binary options, make sure you do your checks first. An app may look professional, but the company or individual behind it may be difficult to identify, may be based overseas and may not be licensed by ASIC. Always check that the entity is licensed to trade binary options in Australia on  ASIC's Professional Registers. Keep in mind that trading in binary options through an app is a highly risky investment. 

Binary options are a high risk, unpredictable investment option. Before you invest, seek professional financial advice to make sure they are suitable for you.

Related links

Last updated: 10 Nov 2017