You have to hand it to Wall Street, they are never at a loss for finding new ways to get people to speculate with their hard earned money. While investing is generally seen as a positive way to grow one’s money over time, day trading and other speculative activities are very risky, particularly for the unseasoned trader. The latest promise of fast money comes in the form of something known as binary option trading.
What Are Binary Options?
Binary options are extremely short term options traded on a security. They are an all or nothing proposition bet on the price movement of a particular security (such as a stock or currency pair). The investor is making an investment on the price of a particular security with the hopes that the currency will move in the direction that they believe it will in a set period of time. This is best explained with an example.
Investor A believes that Stock A will increase from its current price in a short period of time. The current price per share sits at exactly $10. The Investor purchases a binary call option because he or she believes that the stock is going to go up in the span of say one hour (binary options have a variety of expiry time options). The Investor selects the amount to invest (as low as $1) and places the trade. If the investor is correct and the price of the currency increases by a greater amount than the investor gets his or her money back plus a percentage. That percentage can range from 70-95%. If correct on a $100 investment, the investor would receive between $170 and $195 back on his or her investment.
What Is The Downside?
The trouble with binary options is that they are literally an all or nothing proposition. If the Investor in the above example is wrong about the price of the stock at the end of the hour, then he or she is going to have to sacrifice the full $100 invested. That is potentially a very big loss! This means that the investor has to be correct on his or her predictions well over 50% of the time to be a long term winner. That is difficult to do when the expiry time on these options is so short.
Just Like Gambling
Binary option trading is just like gambling in that it is an all or nothing proposition. The investor either earns the full return (on a correct pick), or loses it all on an incorrect one. Also like gambling, the illusion of options is given. When trading binary options the investor is able to choose call (up) or put (down) options on a variety of different securities. This gives the investor the sense that he or she has some control over what they are doing. In reality, it is mostly random. The investment will win sometimes and lose other times. In the end, the investor ends up losing because of the fact that they do not get a full 100% return on their correct picks.
Also, similar to gambling, the Investor is having to compete against the house which in this case is the binary options broker. Many of these brokers also offer investors bonuses for making their first deposit and trading often. This is similar to the bonuses that casinos offer to their loyal players. Binary options are best avoided by everyone who doesn’t want to lose money.