What Constitutes a Binary Options Contract?
A binary option trade is actually a contract. Contracts have certain features, as well as, terms and conditions which govern them. A binary options contract will therefore have certain features and specifications.
So what are those features and specifications that are common to binary options trades?
All binary options have a date or time that they expire. At this time, the value of the asset on expiry (expiry value) is assessed against the value of the asset when the trade was made (entry price). If a directional binary option (Up or Down) was the trade that was made, the outcome of the trade based on what the expiry value is versus the entry price will determine if the trade is settled as a profit or loss.
Also known as the settlement value, this is the value of the option contract when the trade expires. The settlement value determination varies on US and European binary options platforms. On US platforms, settlement value is either 0 (losing trades) or 100 (winning trades). On European platforms, settlement value is the price at which the option ends, with payment being made if the settlement value is higher than market price (CALL trade) or lowr than market price (PUT trade).
The strike price is the target price used in determining the outcome of the trade. The strike price is most relevant in the Touch trades (Touch/No Touch or One Touch), the Ladder trades and the Tunnel trades. By comparing the expiry value to the strike price, the trade is shown to either be in the money or out of the money. Some trades have one strike price (Touch) while others have multiple strike prices (Ladder).
Every binary options contract is traded on a financial asset. This is the particular market, exchange, commodity, currency or stock that is being traded. It is the volatility of the underlying asset that provides the basis for trades. The assets are grouped into four classes:
- Stock Indices
Underlying Market Price
This is the real-time market price of the asset traded in the underlying contract. For most trades, the market price is used as the benchmark price for the trade (strike price). Some online platform allow traders to choose a different price as strike price (e.g. in the High/Low trade on BetonMarkets).
This is the basic unit of an options trade. In conventional options, a contract is made up of 100 units of the asset, but in binary options, whatever the trader has chosen as investment amount will serve as the contract value. For NADEX, one lot of the asset represents a contract.
The bid price is the premium price that a trader will pay to the dealer for opening an option to sell a contract, or to close a buy order. This feature is used in NADEX and on AnyOption to trade the Binary 0-100 contract.
This is a term used to define a bet strategy which is based on an expectation that the price of the underlying asset will drop. A trader will use a PUT on an open sell order.
This is the premium price that a trader will pay for buying a position from the dealer. This is equivalent to placing a CALL trade on a position anticipating an increase in the price of the underlying market. It is also the price paid by a trader who has an open position to sell and wants to close it out.
This is the difference between the bid price and ask price. It is the broker’s compensation. In any market, an increase in trade volume or increase in liquidity will tend to cause the spread to narrow. The reverse is also the case: little volume and liquidity will cause spreads to widen. In NADEX binary options spreads are interpreted in the context of the total return.
This is a service charge that the trader pays on each transaction in the market. This is usually a fixed fee as opposed to the spread which is variable. NADEX charges $1 per transaction while Cantor Exchange charges $0.9 per fill on a price you make and $0.9 per in-the-money result. Different firms charge different commissions. Online binary options brokers do not charge separate commissions. The charges are billed into the trade.
These terms explained above are the key features of binary options contracts, and they will be encountered whether the trader operates on NADEX or on one of the regulated and uregulated online binary options platforms. As a trader it is your responsibility to understand what these terms mean in practice. Most brokers should provide this information in their help section together with additional information on how to trade on their platform.Published in Education