Published On: Sun, Nov 25th, 2012

Differences between Binary and Vanilla Options

The idea of option trading has been in existence for a lengthy period of time. Initially, this method of speculation stayed within the elite preserve of professional and institutional investors and was accomplished by over-the-counter dealings using minimum regulatory control. The first noteworthy event to transform this image occurred in 1971 when the Chicago Board of Trade designed the first supervised options trading platform by forming the Chicago Board Options Exchange (CBOE). The CBOE was a groundbreaking body which still functions these days as the biggest options trading environment in the world.

Since then, protocols were substantially upgraded and the quality of options transactions enhanced. The Options Clearing Corporation (OCC) was created during this period in order to guarantee that traders bought and sold securities precisely as they were advertised. The OCC held the legal capability to instigate bans in cases of misbehavior. Binary options finally evolved from standard options as the direct result of a forceful requirement to create a more user-friendly investment vehicle with minimum complexities.

However, as the initial form of binary options was still transacted as over-the-counter trades, this new concept was still operated only within exclusive circles using minimum regulatory management and subjected to low market liquidity. In 2007, the OCC presented a rule change to permit binary options to be traded on the major stock exchanges. The US Securities and Exchange Commission (SEC) approved this ruling early in 2008 by sanctioning the listing of binary options as tradable contracts on international financial markets. In May of that year, the American Stock Market became the first global exchange to offer binary options publically. The CBOE followed in its footsteps in June.

In recent times, there was been a surge in binary options trading as a result of the launch of highly sophisticated tools and platforms. Binary options are comparable to traditional options since their payouts are issued at expiry time.  The central difference between a traditional and a binary option is that you will need to forecast the definitive size of the price movement for the former but only the direction of the latter.

This variance makes trading binary options a much less complicated investment to trade. Although your prospective returns may be restricted, more importantly your risk exposure per trade is dramatically reduced. Consequently, binary options are also termed fixed rate options (FRO) since their agreements have predefined fixed return and rebate percentages. Always keep in mind that binary options professionals first attend to their risk exposure before dreaming about their profit potential.

Here are some other major variances between traditional and binary options:

1.   Expiry Times    

Traditional Options expire once a month.

Binary Options have a large diversity of expiry times including daily, hourly, 15 minute and even 1 minute.

2.   Size of Payout

Traditional Options have a flexible payout which is reliant on the finishing price of the underlying asset at expiration.

Binary Options has a fixed payout which is advised at execution time.

3.   When are Payouts made?

With Traditional Options, payout times are deduced by determining a quite involved correlation between the strike and final prices of the underlying asset.

With Binary Options, forecasting the time of a payout is far simpler as it occurs at the pre-selected expiry time.

4.   Can you action a payout yourself?    

Traditional Options: Yes, because these variants of options can be discharged before their expiry times. .

Binary Options: No, because binary options can only be cashed-in at expiration.

So, how can you best try to exploit these benefits of binary options? If you attempt to identify new binary options trades that possess good profit potential then your selection process must satisfy certain criteria. You should assess these specifications before you even consider instigating any new positions. You will find that the more effort and attention that you apply to evaluating the potential quality of each of your new trades, then the better chances you will have of accomplishing both success and profits. Your own psychology will partly determine the amount of risk that you are willing to accept. In fact, there are two main factors that you will need to consider. They are the size of your account balance and your ability to deal with uncertainty. You should devise a good money management strategy based on these two central concepts in order to help you determine your best solution for controlling risk.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.