# Binary Option

## Definition

A binary option is a financial option in which the payoff is either some fixed monetary amount or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The former pays some fixed amount of cash if the option expires in-the-money while the latter pays the value of the underlying security. They are also called all-or-nothing options, digital options, and fixed return options.

## Binary Option

A binary option is simply a ‘yes’ or ‘no’ settlement between two people, and involves a certain asset and a particular (short) time period. To better grasp the concept of binary options, you must understand the following terms.

## Time frame

Just like most dealings in the stock-market, binary options are also bound by a certain time period. Only that this case involves a fairly short period. It could be anywhere from a few hours to a week. This time-frame is specified down to the exact minute of the deadline.

## Strike price

The strike price is basically a base-price that settles a binary option. It is based on the current market price of the asset. On the basis of this current market price of the asset, a future price is determined by the buyer.

## Cost of binary option

The cost of buying a binary option from a seller always remains between \$0 and \$100. It is often considered as a probability of hitting the strike price. For instance, if the probability of hitting the strike price is 0.3, the cost of buying the option becomes \$30. However, it could be anywhere between zero to hundred regardless of any probability.

## How does a binary option work?

In a binary option, the buyer determines the near-future price of a certain asset. This predicted future price is called the strike price of the option. If the asset has a fifty percent chance of hitting the strike price, the seller will charge \$50 for the option. At the same time, a time-frame or expiry time (deadline) of binary option is also set. If at the time of expiry, the asset goes over the strike price, the buyer gets a \$100 (always fixed) for every binary option bought. If the strike price is not met, the seller gets \$100 per option.

Example:

• Price of an asset: \$15
• Strike price set at 12:00 pm: 15.20
• Buyer’s bid for the option: \$10
• Seller’s bid for the option: \$12

Let us suppose the binary option is sold for \$11. If at 02:00 (deadline), the price of the asset is \$15.21 (basically anything above \$15.20), the buyer gets \$100, and the seller goes empty handed.

If the strike price is not hit, which means that the price of the asset at 02:00 pm is \$15.19 or anything less than that, the seller gets the \$100 while the buyer goes empty handed.

The binary option does not exercise any right over the possession of the asset itself.