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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.

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
  • Deadline: 02:00 pm
  • 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.


Further Reading


Numerical Solution for Binary Option Following Constant Elasticity of Variance Model [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-NFJJ200602004.htm'>PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

Empirical case study of binary options trading: An interdisciplinary application of telecommunications methodology to financial economicsEmpirical case study of binary options trading: An interdisciplinary application of telecommunications methodology to financial economics
www.igi-global.com [PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

Fuzzy pricing of binary option based on the long memory property of financial marketsFuzzy pricing of binary option based on the long memory property of financial markets
content.iospress.com [PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

Fractional white noise calculus and applications to financeFractional white noise calculus and applications to finance
www.worldscientific.com [PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

Binary option pricing model with transaction costs and the payment of dividend <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-SXSZ200806005.htm' />Binary option pricing model with transaction costs and the payment of dividend [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-SXSZ200806005.htm'>PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

A binary option pricing based on fuzzinessA binary option pricing based on fuzziness
www.worldscientific.com [PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …

Binary Options as New Financial Instruments and Their Integration into the Financial SectorBinary Options as New Financial Instruments and Their Integration into the Financial Sector
www.atlantis-press.com [PDF]
… Computer Science,Yan′an University,Yan′an 716000,Shaanxi,China);Option Pricing about … University,Lu'an 237012,China);Study on the pricing of binary options in the … of Economic Information Engineering,Southwestern University of Finance & Economics,Chengdu 611130 …