What Is A Nadex Binary Option?
A Nadex binary option, in its most simplistic definition, is basically making a true or false statement about the market.
Binaries offer many more opportunities than this straightforward definition -- but this is where you must start, so you can master all of the trading opportunities that are available in the emerging instrument of binary options. After you understand the uncomplicated definition, you quickly learn there is much more than buying or selling a contract and holding it to expiration.
And here's an important tip: remember that not all binary options are created equally. This article is specifically referencing binary options available on the CFTC Regulated N.A.D.E.X. Exchange in Chicago.
For example, consider this simple statement:
Gold will be above 1334 at 1:30 PM on Friday March 14th, 2014. TRUE or FALSE?
The four parts of the binary contract are:
- 1) Gold is the underlying market
- 2) 1334 is the strike price
- 3) 1:30 PM is the expiration time
- 4) March 14, 2014 is the expiration date
If you think this statement is true, you buy the binary. If you buy the binary and you are correct, and gold is greater than 1334 at 1:30 PM on Friday March 14th, 2014, then you will be profitable.
If you think this statement is false (that is, you think gold will NOT be greater than 1334 at 1:30 PM on Friday March 14th, 2014), then you will sell the binary. If you decided the statement was false by selling the binary and you are incorrect -- and gold is, in fact, greater than 1334 at 1:30 PM on Friday March 14th, 2014 -- you will not be profitable on the trade.
A binary's value ranges between $0 and $100. The price of the binary reflects the market's perception of the probability that the market will expire above or below the binary strike.
So let's say gold is trading right now at 1334. Then you would be able to buy the binary for $50. The reason it would be $50 is there is a 50/50 probability that the price will go up or down from right where it is at this moment -- and at this moment, gold is right at the strike.
At the same time, another trader could sell the binary for $50 for the same reason since the gold future contract price is trading right at the binary strike.
If, when the binary contract expires, gold is above 1334, you would receive $100 payout. The $100 is a result of the initial $50 of risk you put up, plus another $50 in profit from the trader who sold the binary. By buying the ATM (At The Market) contract, you have balanced your risk and your reward.
You can do more than a 50/50 trade though on Nadex binaries. You can also buy a binary that has a strike higher than where gold is trading. For instance, if gold was at 1334 and you bought the 1344 binary, then you would be able to risk less money (i.e. $25) and make more money (i.e. $75).
Why the lower risk and higher payout? Because gold now has to move up 10 points for you to be profitable on the trade, and expire above 1344. The probability is lower, so the risk is lower and the payout is higher. By buying the OTM (Out of The Money/Market) contract you have increased your potential profitability.
You can also buy a binary whose strike is lower than the market. For example, if gold is at 1334, then you could buy the 1324 binary contract. You would have a higher risk (i.e. $75) and a lower reward (i.e. $25). Why the higher risk and lower reward on the bought lower strike? Because the probability of the trade is higher.
Gold can stay flat at 1334 or move up 100 points, or even expire down nearly 10 points lower and you will be profitable, as long as gold expires greater than 1324. By buying the ITM (In The Money/Market) binary contract, you have increased your probability of being profitable.
A huge thing to remember is that, on all Nadex binary options, you can also close the trade early. You do NOT have to hold the trade until expiration. You can do this to lock in profits or limit losses.
To see examples of trading on Nadex binaries and spreads, see these articles posted on Benzinga, click here.
To learn more about how to trade binary options and for indepth binary trading strategies, tools and trade rooms see ApexInvesting.com
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