Just like other types of trading, binary options trading can yield massive profits if you are able to correctly predict the movements of the market.
With binary options, you do not need to own an asset to profit from market movements. Instead of actually buying a share when you believe the share price is about to go up, you buy a binary option that pays out if your prediction comes true. In this sense, binary options are similar to contracts for difference (CFD:s).
Binary options are available for a wide range of underlying asset types, such as company shares, commodities, currency, and cryptocurrency. You can even speculate on the movements of indices.
Profit or loss
For many traders, an appealing aspect of binary options is that they are, well, binary. Even though some more exotic binary options have been created, a vast majority of the binary options work like this: if your prediction comes true, you get paid. If not, you lose the money you risked.
With standard binary options, you risk a specific amount of money and you know beforehand how much you will get paid if your prediction comes true. Many traders appreciate the clearness of this.
Who is my counterpart?
When you buy and sell shares on a stock exchange, your counterpart is other traders. That is not the case with binary options. It is your broker that creates the binary options and serve as your counterpart.
Binary options brokers create the binary options in a way that gives them a statistical edge over the traders. It is not simply a ”toss a coin” scenario where you and your counterpart each have the same chance of winning.
This is how the notable license issuer CySEC defines a binary option for the purpose of their Policy Statement PS-03-2019.
”Binary Option” means a derivative that meets the following conditions:
a it must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event;
b it only provides for payment at its close-out or expiry;
c its payment is limited to:
i a predetermined fixed amount or zero if the underlying of the derivative meets one or more predetermined conditions; and
ii a predetermined fixed amount or zero if the underlying of the derivative does not meet one or more predetermined conditions.
Many brokers that offer binary options also offer leverage. If you use leverage, you borrow money from the broker and use it to finance part of a deal.
Example: Annica wants to risk €500 on a binary option. She takes €50 from her account and borrows the remaining €450 from the broker.
Using leverage is appealing since you can make larger trades. However, it is important to understand that while leverage will amplify profits it will also amplify losses.
Take the scenario above. Let´s say Annica´s prediction of the future did not come true and she lost the money she risked on the binary option. She now has to pay back €450 to the broker. If she had only risked her own €50, she would not be in that situation.
Today, many brokers offer negative balance protection, which means that you can not end up owing them more money than the total value of the assets in your account. Before you rely on this to protect you, make sure you know the exact terms and conditions of the negative balance protection, to avoid surprises.
In many parts of the world, lawmakers and license authorities have limited how much leverage brokers are allowed to give to non-professional traders. This is not unique for binary options trading.
Binary options within the European Union
In 2018, the European Securities and Markets Authority (ESMA) banned the marketing, distribution and sale of binary options to retail clients in the European Union. (ESMA is EU securities market´s regulator.) The temporary prohibition came into effect on 2 July, 2018.
In the summer of 2019, ESMA announced that they would not prolong the temporary prohibition anymore, and would allow it expire.
The reason for not prolonging the ban was that so many national authorities within the EU had now enacted their own permanent rules regarding the marketing, distribution and sale of binary options to retail clients and that those rules were at least as stringent as ESMA´s temporary rules.
One notable example of a EU membership country that now has their own binary options rules to safeguard retail clients is Cyprus. On 10 July, 2019, the Cyprus Securities and Exchange Commission (CySEC) published a Policy Statement on the decision to impose national measures regarding the marketing, distribution and sale of binary options, pursuant to Article 42 of Regulation (EU) No 600/20141 (MiFIR).