Definition of Binary Options
An option is a derivative contract where an investor possesses rights to purchase and sell assets such as commodities, foreign currencies, and common shares etc . There are two types of options like traditional, regular or vanilla options as well as binary or digital options. The market dynamics and mechanics for options contracts are same in every economy. The only difference relies in the manner in which options trading is regulated in each country.
In derivatives, binary option represents a trading form where traders or investors predict movement in the prices of underlying assets, commodities and securities etc. The word “binary options” means “representing two parts” where any investor/trader possessing an asset predicts that either the prices will increase (in case of a call option) or the prices are about to decline (for a put option). In other words, investors in any market are betting whether the price of an asset or any other underlying commodity is going to increase or decrease.
Differences between Traditional or Vanilla and Binary Options
Although these two types of options seem similar to each other, yet there are some notable differences that separate the dynamics of each option. They are elaborated in succinct detail as follows:
Complexity of Valuation of the Option Contracts
When any trader enters into a binary options contract, he is sure of one of the two possible outcomes. Either the binary option will be in-the-money or out-of-money. Either investors will earn return on their investment or they will lose their investment amount in binary options. In simple terms, the valuation of binary options is simple. In contrast to this, the valuation in traditional or regular options is complex which depends heavily on multiple factors such as the exercise or strike price, the inherent market volatility, the time value and option type (American or European) etc.
Maturity or Expiration Time of the Option Contract
Regular, traditional or vanilla options tend to have a maturity from one month to two years whereas binary option contract mature in a short period of time such as sixty seconds, fifteen minutes, one hour or maximum up to one day or twenty four hours. Compared to vanilla or regular options, short-term maturity in binary options allows traders to make instant profit by enabling them to enter a trade within five to fifteen minutes before the option expires.
Exercise Right
Traditional options can be exercised at any point of time before maturity as they could be sold at any time due to existence of the secondary market. In contrast, binary options can only be executed or exercised at maturity. The trader has to wait until the contract expires to determine if he has made a profit or loss.
Contract Payoff or Probability of Making Profit
The payoff or profit in traditional options is conditional to the price level of an underlying asset at maturity. If traders assume traditional “call” options, the higher the price of an underling asset at expiration time, the more will be the payoff or profit. Comparatively, binary options provide one facility that traders know in advance the possibility to win or lose before entering into the contract.
In traditional options, traders pay per contract which is also known as “pips”. The amount of profit or loss in traditional options depends heavily on the number of pips difference between the strike price and expiry level. In contrast to this, the profit percentage is predetermined in binary options that may range from fifty to ninety percent if the option contract matures “in-the-money”. Overall, the payout in traditional options is fixed whereas binary options contain a fixed profit range.
Binary Options in China
In China, the trend for binary options trading has been increasing. Numbers of binary options platforms, such as 888binary.com, have been launched for Chinese traders. To eliminate the language barrier, these platforms are designed and written in Chinese language with no English vocabulary at all. All magazine articles, contents, asset information and learning center are developed using Chinese language. This is so because the regulatory authorities wish to target Chinese investors and make binary options platform more appealing to them .
Despite this, there are some issues in the Chinese market which must be dealt with. During the very first week of 2016, the Chinese stock market declined sharply as majority of individual investors were betting about increase in prices per share. Due to this single problem, the Chinese economy slowed down and the market was made stagnant for regulatory authorities to interfere. In light of this problem, there is an opportunity for Chinese traders to make profits. This is so because the decline of Chinese stock market and economic slowdown has made it unlikely that the asset prices will fluctuate frequently .
In other words, Chinese traders can easily predict if the asset prices are going to increase or decrease as the price risk has declined sharply. Regulatory authorities in China do not wish the asset prices to move up and down frequently. In this regard, Chinese traders can earn a sure payout or profit by entering binary options contract. They may either take “call” or “put” position depending upon their investment analysis and market knowledge.
Because the Chinese population over 1.2 billion, the retail trade conducted in binary options all over China makes it difficult for Chinese authorities to regulate and monitor actions of billions of people (Chinese traders) at the same time. However, because Chinese traders tend to be more risk averse than other investors all over the world, trading in binary options contract in circumstances of economic slowdown and stock market crash is very lucrative for earning profit .
Explanation and Example
For Chinese investors, the idea of entering into binary options is really very simple and easy to understand. Suppose, if Chinese trader predicts that the price of gold is going to increase in one hour, he will enter into a “Call” option and decide the amount he is willing to invest. If after one hour, the price actually exceeds than what it was one hour ago, the Chinese trader has earned a fixed and predetermined payout or profit regardless of the level of increase in the gold price. Vice versa will be the situation if the gold price declines and the Chinese trader would suffer a fixed loss in his case. This could easily be understood by an example or illustration.
Suppose any investor or trade in China wants to enter into an option contract pertaining to foreign currencies such as Euro and Dollar. In this regard, the very first step is to select an asset, which is, the exchange rate between Euro and US Dollar (EUR/USD). Currently, suppose that the ongoing rate concerning EUR/USD is 1.37650.
The second step in this binary option trading is that the Chinese trader would predict that this exchange rate will decline in thirty minutes and will hit a level less than 1.37650. To enter into binary option trade, the Chinese investor may decide to invest any amount, suppose $100 in this example. After deciding the investment amount, as the Chinese trader predicts that the exchange rate would decline, he will enter into a “Put” option considering that the trade return would be eighty seven percent.
If after thirty minutes, the prediction of Chinese trader materializes and the EUR/USD exchange rate is trading below 1.37650 at the current rate of 1.37400 and the binary option contract is automatically finalized by the broker, the Chinese trader has made a profit. On an investment of $100 with “Put” option, the Chinese investor has earned $87 ($100×87%) in just a single trade.
References
Eleutheriou, N. (2015, April 9). China Binary Options country Report. Retrieved May 3, 2016, from Binary Options Wire: http://www.binaryoptionswire.com/china-binary-options-country-report/
Folsom, W. D., & Boulware, R. (2014). Encyclopedia of American Business. Infobase Publishing.
Kuzentsov, N. (2015, September 9). Dian Chu How China’s Slowdown Impacts Binary Options Trading . Retrieved May 3, 2016, from EconMatters Research: http://www.econmatters.com/2015/09/how-chinas-slowdown-impacts-binary.html
OptionAffiliate. (2013). The growing trend of binary options in China. Retrieved May 3, 2016, from Binary Options Affiliate Program: http://www.optionaffiliates.com/binary-options-china-aspx/
