In a binary options trade, once a trader selects a suitable asset (equity, commodity, currency or index) and forecasts the probable direction of price movement, a call or put option should be purchased. To do so, a trader should have a clear understanding of the technical lingo, which is unique to options trading.
Asset: Any item, which has a money value, is referred to as an asset. An asset can be tangible or intangible. As far as binary options trading is concerned, the asset can be an equity (common stock of a company), commodity (precious metal, wheat, rice, sugar, cotton, zinc, lead, etc.,), index (Dow Jones, Nasdaq, FTSE, DAX, etc.,) or currency pair (USD/CHF, EUR/USD, AUD/USD, NZD/USD, etc.,).
Expiry: It is the time for which a contract remains valid. A contract becomes void as soon as the expiry time passes by. In the case of a binary options trade, the value of an asset is calculated based on the existing price at the end of last second of the expiry time. For example, if the expiry time is 60 minutes, then the prevailing price at the end of 59 minutes and 59 seconds is used to determine the outcome of a trade.
Strike price: It is the reference price based on which the profit or loss is calculated in a binary options trade. For example, let us assume that a binary options trader expects the price of crude, which is currently trading at $35, to go up. He proceeds to purchase a binary call option contract of crude priced at $40. Then the strike price for this trade is $40. At expiry, if the price of crude is $40.01 or more, then the buyer (option holder) will receive the stipulated amount.
Premium: It is the difference between the prevailing market price and the price paid to the writer of an options contract. It is a term regularly used in vanilla options. The term can be understood clearly from the following example:
A trader anticipates a decline in the price of Apple (AAPL) stock to $95. Let the prevailing share price of Apple is $101.15.
A vanilla options trader would purchase a put option contract with strike price of $95. Let the premium for the strike price is $0.10. Thus, for buying 20 lots (1000) of Apple put option contract, the investment required is $100 ($0.10 * 1000). Let the expiry period is one month. If the traded price of Apple is $94 at expiry, the premium would have risen to approximately $1. The trader can sell the put option contract for a profit of $100.
If the traded price of Apple is $94.99, then, theoretically, the premium would be only around a cent. Thus, after deducting the exchange related charges, the buyer (options holder) would end up in a small loss.
For the same scenario, a binary options trader would decide the investment first. Let us assume that the binary options trader is willing to take a risk of $100. The binary options trader would then proceed to purchase a binary put option contract with a strike price of $95 from a binary broker offering a payout of 92%. Let the expiry date is one month. If Apple trades at even $94.99 at expiry, then the trader’s account will be credited with $192 [$100 (investment) + $92 (payout).
In-the-money: An in-the-money option contract will have a value more than $0 at expiry. For example, if a binary option trader has bought a put option contract for crude with a strike price of $35, then the contract is said to be in-the-money, if the price of crude is at least a notch below $35 at expiry. To put it simpler, a profitable trade is usually referred to as in-the-money contract.
Out-of-money: At expiry, an out-of-money option contract will have no value. For example, if a binary option trader has bought a put option contract for crude with a strike price of $35, then the contract is said to be out-of-money, if the price of crude is at least a notch above $35 at expiry. To put it simpler, a loss making trade is generally referred to as out-of-money trade.