Popular Binary Option Trading Strategy Types

Binary options have become increasing popular as a trading vehicle for those interested in speculating on forex rates, commodity prices, stock prices and market indexes.

Although usually traded from the long side, binary options can be combined into several option trading strategy types that are similar to those described in just about any option trading guide that focuses on strategies involving regular or “vanilla” options.

The primary difference seen with binary options is that they have a fixed payout at expiration, rather than the time and price sensitive payout that is characteristic of vanilla options.

Binary options also tend to be traded with considerably shorter maturities than vanilla options, often expiring one week to less than one hour from initiation of the binary option position — depending on what the binary option brokerage used offers.

The following sections will cover some of the more common binary option trading strategy types employed by retail traders with access to a binary options broker.

Purchased Binary Call Option Trading Strategy

This option trading strategy involves paying an up front premium to purchase a binary call option that will pay out a fixed amount if the underlying market is above its strike price at expiration.

Traders might use this bullish option trading strategy if they thought the market might rise by expiration, but they did not wish to take the added risk of stop loss sell order slippage or being triggered on a stop loss sell order before ultimately being proved correct on the market’s anticipated upward direction.

Purchased Binary Put Option Trading Strategy

This option trading strategy involves buying a binary put option for an up front premium that will pay out a predetermined amount if the underlying’s market price is below the option’s strike price at its expiration time.

Traders could employ this bearish option trading strategy if they anticipated that the market could fall by its expiration time, and they wanted to avoid the added risk of stop loss buy order slippage or being triggered on a stop loss buy order before the market eventually moved in the anticipated downward direction.

Purchased Binary Straddle Option Trading Strategy

This option trading strategy involves purchasing both a binary put option and a binary call option at the same strike price that is usually close to at the money in return for an up front premium. These binary options will each pay out a fixed amount if the underlying market is better than their identical strike price at expiration, but they will both not pay out at the same time.

Traders might employ this usually initially neutral option trading strategy if they expected the underlying market to move significantly by expiration, but they were not sure in what direction it might go.

In addition, they might buy a straddle made up of binary options if they did not want to take the extra risk of slippage on stop loss orders or being triggered on stop loss orders after initiating a position in a particularly volatile market.

Purchased Binary Strangle Option Trading Strategy

This option trading strategy involves paying an up front premium to purchase both a binary call option and a binary put option at different strike prices that are usually a similar amount out of the money. Each leg of the strangle will pay out a fixed amount if the underlying market is better than their strike price at expiration, but both legs will not pay out at the same time.

Traders might use this usually initially neutral option trading strategy if they thought the underlying market might move substantially by expiration, but they did not know in which direction.

Furthermore, they might use a strangle consisting of binary options if they did not wish to take the added risk of stop loss order slippage or being triggered on a stop loss order after opening a position in an especially fast market.

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Introduction to Binary Options

Binary options currently represent one of the quickest growing sectors in the finance industry. Although binary options have been available in the professional Currency Option Trading market for well over a decade, part of this growth stems from the fact that commodity, stock and forex binary options have become increasingly available to and popular among retail traders in the last few years.

As a result of this growing retail demand, many binary options broker websites currently offer a quick and readily accessible way of obtaining up to date pricing on a range of stock, commodity and forex binary options in relatively small dealing amounts that are accessible to retail traders.

Furthermore, using these online Option Brokerage facilities to trade binary options can significantly broaden the risk taking methods available to those individuals actively engaged in stock, commodity and currency option trading.

How Binary Options Work

Basically, binary options require a trader to pay an upfront cost or premium for the potential ability to earn a predetermined amount or payout if the binary option ends up in the money when the underlying financial market is observed at the option’s maturity date and time that is commonly known as the option’s expiration.

The phrase “in the money” or ITM simply means that the rate or strike price of the binary option is more favorable than the prevailing market in the option’s underlying instrument at the time of the option’s expiration. 

The alternative phrase is “out of the money” or OTM, and this refers to the situation where the binary option’s strike price is less favorable than the market at expiration.

Similarity to Betting

These relatively simple premium and payout characteristics of Binary Options make them similar to placing a bet on an underlying financial market with a predetermined set of outcomes.

In essence, the premium paid for a binary option represents the amount of the wager or stake that the trader gambled on their bet, while the binary option’s payout represents the winnings to be gained if the trader’s bet is ultimately successful.

This notable similarity of employing a binary option trading strategy to more traditional betting can assist novice option traders who are also gamblers in becoming more comfortable as they endeavor to learn option trading and how to employ derivatives in their trading strategies as a potential form of portfolio diversification.

Basic Components of a Binary Option Trading Strategy

The first decision to make when considering trading binary options is what underlying asset or financial market you wish to place a bet on. These assets might include forex rates, as well as commodity, stock or stock index prices.

The second decision will be to determine the amount of time until expiration of the binary option you wish to purchase.

The last decision will be the forecasted direction of the binary option based on your prediction for the underlying market’s movement during the time frame until the option’s expiration. Basically, if you think the market will rise, you will want to purchase a call, but if you think the market will fall, you will want to purchase a put.

Binary Options Terminology Explained

For those who wish to learn option trading, and how to trade binary options in particular, one of the first steps to take is to gain a thorough understanding of the highly customized terminology commonly used to refer to these various aspects of these derivatives.

To assist in this endeavor, the following list consists of frequently used words and phrases related to trading binary options that might make up part of a binary option trading guide.

Nevertheless, it is worth noting that the terms used to refer to characteristics of binary options can vary somewhat between different binary option brokerage firms, so be sure to clarify exactly what these terms mean at the binary options broker you intend to use.

Asset: Also sometimes known as the underlying, this term refers to a commodity, stock, index or currency pair upon which the binary options are based.

At the Money (ATM): The situation where the binary option’s strike price is the same as the current price of the underlying.

Binary Option: An option that pays out a fixed amount if in the money in return for a known premium that is paid up front.

Call Option: Sometimes called an “above” option, it gives the purchaser a fixed payout if the underlying market is higher than the binary option’s strike price.

Current Price: Refers to the presently prevailing value of the underlying asset that binary options are based on.

Digital Option: Another term used to refer to binary options, and especially to those binary options that have fixed odds.

Expiration: The date and time that binary options mature and when these options are determined to be in, out of, or at the money based on the value of the underlying.

In the Money (ITM): The situation where the binary option’s strike price is more favorable than the current price of the underlying.

Out of the Money (OTM): The situation where the binary option’s strike price is less favorable than the current price of the underlying.

Payout: The amount that binary options generate for the purchaser if they expire in-the- money.

Premium: The up front cost involved in purchasing binary options.

Put Option: Sometimes called a “below” option, it gives the purchaser a fixed payout if the underlying market is under the binary option’s strike price.

Straddle: A binary option trading strategy that involves purchasing both a binary put option and a binary call option with the same strike price.

Strangle: A binary option trading strategy that involves purchasing both a binary put option and a binary call option with different strike prices, usually with both strike prices set initially out of the money by a similar amount.

Strike Price: The asset price characteristic of binary options that the underlying market must exceed — in the case of a call option — or be below — in the case of a put option — in order for the binary option to generate a payout.

Underlying: This term, also sometimes called the asset or underlying asset, refers to the commodity, stock, index or currency pair that the binary options are based on.

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Binary Options Can Help Avoid Order Problems in Volatile Markets

The limited risk nature of trading binary options helps make purchasing them an especially interesting option trading strategy over very volatile trading periods.

Basically, using a long binary option trading strategy allows a trader to remain involved in a fast market without being subject to especially frustrating trading problems like substantial stop loss order slippage and briefly triggered stop loss orders after which the market subsequently reverses.

Using a binary option trading strategy in such a situation usually involves purchasing binary options that expire soon after the volatile period has concluded. Employing this sort of strategy can help a stock, commodity or forex trader manage such potentially problematic markets in a way that limits their risk to the premium paid for the binary option.

Non Farm Payrolls Binary Option Trading Strategy Example

For example, when a major economic number like U.S. Non-Farm Payrolls comes out, the forex market can go haywire for a short period of time while the news is discounted into the various major exchange rates.

These sharp price swings can result in frustrating forex trading challenges like barely triggered stop loss orders from which the market promptly recovers. Such volatility can also result in substantial slippage on stop loss orders that can be a painful surprise to a trader expecting to be filled at their order level.

A savvy trader might use a forex option trading strategy that involves purchasing a binary option straddle. This is a two legged option trading strategy in which both a binary call option and a binary put option with the same strike price are purchased on the underlying exchange rate.

Thus, if the Non-Farm Payrolls result comes out substantially different from the market consensus and the forex market reacts strongly, the trader will likely be able to profit on the leg of the binary options strategy that has gone in the money.

Furthermore, if the volatile market then reverses and returns to previous levels, as is sometimes the case, then the trader may be able to benefit from profits on the other leg of the binary option trading strategy.

Beware of Higher Premiums and Lower Payouts

It is perhaps worth mentioning that some online binary option broker websites are probably wary of writing binary options over such volatile trading periods due to the greater risk involved.

As a result, they may reduce payouts on binary options accordingly, and they might also mark up the premium cost of purchasing such riskier binary options. This effect can be even more notable with especially short term binary options with tenors that include a major risk event that is widely expected to create volatility in the underlying market.

Nevertheless, traders who have access to a decent binary option brokerage service that offers competitive pricing can usually still take advantage of the useful limited risk characteristic of binary options to help them manage risk appropriately while still being able to participate in especially fast markets.

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Benefits of Trading Binary Options

Binary options have gained an increasing share of the derivative market for those engaged in active forex, stock and commodity option trading in recent years.

In addition to providing a potentially valuable form of diversification and risk management to a trading portfolio, some of the significant benefits unique to trading binary options are detailed further in the sections below.

Binary Options are Relatively Easy to Understand and Use

Those who wish to learn option trading techniques can benefit from starting with binary options due to the simplicity of their payout structure.

In essence, the premium paid for binary options will be the maximum loss the trader will incur on their positions, while the maximum benefit will be the binary option’s payout if the binary option expires in the money.

Take Limited Risk to Potentially Earn Limited Rewards

One of the primary advantages of purchasing binary options — as with just about any long option trading strategy — is that the trader will know the full extent of the risk they are taking in advance.

Another significant benefit is that they also know in advance how much reward they will earn if their option trading strategy turns out to be correct. This combination of binary option characteristics allows a forex or commodity trader to compute their risk/reward ratio on the transaction very easily.

Furthermore, to a trader, this unique limited risk and payout characteristic of binary options makes the risk of purchasing them a bit like having a guaranteed stop loss order in place that is only triggered if the option is out of the money at its expiration.

When considering the profit side, long binary options somewhat resemble placing a take profit order that can only be executed at the options’ expiration.

Shorter Trading Time Frames

Binary options may be more suitable for active traders due to the common availability of expiration time frames that are relatively short in duration.

While traditional options may take months or even years to expire, a binary option trading strategy can be implemented with a much shorter time period until expiration.

Depending on the specific binary option broker involved, common tenors for commodity and forex binary options can vary from a week to a day. Some option brokerage firms even offer binary option expirations occurring less an hour from the time the option contract is executed.

Accessibility to Smaller Traders

Another advantage of using binary options as part of a commodity, forex or options trading strategy is that they can now be purchased in relatively small minimum dealing amounts from option brokerage firms that cater to retail traders.

This small dealing amount or lot size can also be readily scaled up by more adventurous traders to increase the risk taken on a particular position or option trading strategy.

Trading Volatile Markets Using Binary Options

To a forex or futures trader, the guaranteed limited risk and payout characteristic of binary options can make their returns superior to placing traditional orders in so-called volatile or fast markets that often occur during key announcements and news events.

In essence, a set of stop loss and take profit orders entered in the market to be executed can sometimes suffer from slippage or being missed in volatile trading conditions.

Binary options have gained an increasing share of the derivative market for those engaged in active forex, stock and Commodity option trading in recent years.