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What Are Binary Options (And How Do You Make Money With Them)?

By Edited Jan 20, 2015 1 0
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Investing is often thought of as a rich person's game; something that men and women in power suits with red ties accomplish by shouting into telephones and making lightning fast deals over the Internet at all hours of the day. That can be intimidating, but fortunately for those who want to make their money grow using the magic of the market it's important to remember that everything from stocks and bonds to a savings account is just a numbers game. Some of the games are higher risk, but the idea is the same. You put in a certain amount of money, wait a certain amount of time, and when you withdraw your investment you have more money than you had when you first put it in.

Options are one of the methods that investors use to increase their money, and binary options are a very specific variety. Before adding them to a portfolio though you need to understand exactly what they are and how they work.

For other investment tips check out this article about how to make money trading on the Forex market, or take a look at this piece about how to use an Individual Retirement Account (IRA) to keep your finances healthy.

So What Are Financial Options?

A financial option, in short, is a contract that gives the holder the ability to buy or sell a commodity at a given price. To put that sentence in perspective, let's say someone was buying gold (as many investors do), but that person isn't sure about the future prices of gold. If the investor paid $10.00 an ounce for the gold, then she might buy an option which states that she can sell that gold anytime between now and three months from now for $10.25 per ounce. This contract can be bought for $500.

The keyword in that description to pay attention to is "can." If someone buys an option then she's bought nothing more than a contract which stipulates the terms that an actual commodity can be bought or sold at. The option is something like an insurance policy, which guarantees the investor a rate he or she can use up to a certain date. So if the market goes low, someone can still sell a commodity at a higher price. If the market goes high then the option isn't necessary, but buying it was a way to hedge a bet.

There are two major kinds of financial options: Calls and Puts. A call is used by buyers who want to lock in a low price, betting that a commodity will go up in value and allowing them to buy it cheap. A put is used by a seller, guaranteeing the right to sell a commodity at a certain price that will remain higher in the event it loses worth on the market. Once the use-by date has passed though, options become worthless.

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So Where Do Binary Options Come In?

In a classic case of "I told you that story to tell you this story," binary options have nothing to do with the kind of options mentioned above. It's like the difference between a leopard and a leopard seal; the names might give the impression of a relation, but they're two very different animals.

Binary options, like the options mentioned above, are contracts. These contracts have an expiration date, and refer to a distinct commodity. However, investors can still make money off of binary options even if they don't own the commodity (gold, silver, gasoline, pork rinds, etc.) that the contract refers to. How do they do that?

In short, binary options are nothing more than a formalized stock market bet.

When an investor buys a binary option it comes with a date that it expires on, and it states that a certain commodity will be worth more than a certain amount on that date. The binary option will cost a certain amount, and if the conditions on it are met on a given day then the investor will receive the payout amount on the option. So if someone buys a binary option that says Barnes and Noble stock will be higher than $15 per share on X date, and then the stock is worth $17 on that date, the holder gets the payout. The option may have cost $100, but the payout is $150. or $200. Or $1,000.

A Word Of Warning

Binary options feel simplistic; you win or you lose. There are no additional complications, and no additional investments to be made; the holder either wins by meeting the conditions of the binary option, or gets nothing when the contract's conditions are unfulfilled. Just because the contract's conditions seem simple though that doesn't mean they're easy to make money with.

In order to "win" with binary options it's still necessary for someone to predict which way the market's going to shift. Otherwise an investor is just taking shots in the dark and hoping to come up with a certain number. Since these options can be big or small it makes them available to anyone with a little spare money to invest, but it's still a good idea to be able to accurately predict the market at least 2 times out of 3 before sinking too much capital into what amounts to a stock market wager.

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Bibliography

  1. "Options Basics." Investopedia. 13/01/2015 <Web >
  2. "Binary Options." Investopedia. 13/01/2015 <Web >

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