Binary options are usually attributed to the market Forex, since the main underlying asset for contracts are currency pairs. But the terminology used in trading this type of OTC instruments differs from the generally accepted definitions in trading.
An option is a type of instrument that secures the client's right, but not the obligation, to make a transaction under previously agreed conditions. There is no practice of applying this definition in binary contracts, it is more clearly disclosed in vanilla options.
Vanilla option offers the trader to secure the right to purchase the underlying asset (buy or sell), at a pre-agreed price (strike). The decision on a transaction with a real asset must be made at the time of expiration, after the expiration of the contract.
A vanilla option is similar to a binary option only in that the trader loses only the amount of the option premium in case of rejection (negative outcome).
The premium in binary options is the amount of payment in the case of a correctly predicted one of the two conditions, whereas in a vanilla option, the premium is the cost of the contract.
Binary options differ from vanilla options by the ability to combine several consecutive conditions in one transaction, which follow each other and are tied to certain time intervals. Such complex instruments are called express options.
Call, Put, ATM, OTM, ITM
The highest number of matches in terminology with a vanilla option has a binary contract Above/Below (Call/Put):
- Call - means a forecast for an increase in the underlying asset, at the time of expiration.
- Put - the forecast provides for a fall in the exchange rate at the time of the contract expiration.
- At-The-Money (ATM) – the current tick-to-tick exchange rate coincides with the entry point.
- Of-The-Money (OTM) – the price went in the other direction from the forecast value.
- In-The-Money (ITM) – quotes of the asset are in the right direction of the forecast.
The last two definitions are actively used in the "American" type of contract, which assumes the possibility of changing the terms of the transaction. For example, if an option is closed early:
- in the case of OTM, the trader completely loses the bet (investment) – the amount paid when opening the contract,
- in the case of ITM, the bidder receives a pre-agreed part of the premium.
If an ATM situation occurs at the time of expiration, the trader may lose both the bonus and the investment. Pay attention in advance to payments in the event of an "At-The-Money"situation.
Refund, strike price, ask, bid, spread
Expired OTM binary options may have a degree of protection (refund, compensation) – a percentage of the lost bet, which the broker returns to the client's account.
The value of the price at the time of expiration is called the exercise price of the option, decisions on payments are made based on this fixed figure.
The underlying asset sometimes contains two different prices:
- ask (ask) – the price level that will be fixed when the movement is forecast "Higher";
- bid (bid) – the entry level accepted when calculating the forecast "Lower"at the time of expiration of the transaction conditions.
The difference (distance) between these prices is called spread. In most cases brokers do not make distinctions for the opening prices of a binary option, using a single value.
Exotic binary options
Exotic binary options are a type of contracts with an unusual underlying asset. They are based on any conditions that assume a double outcome, for example:
- weather, harvest/drought, volatility, random indexes of the random number generator, victory/defeat of any kind of competition or the outcome of political elections, etc.
Limit (pending) option order
Limit (pending) option an order is a type of option with pre-agreed conditions and execution time, which takes effect only if the asset quotes reach a certain (of the pending ) price level.
"American", "European", "Asian" sessions
"American", " European", " asian" sessions – time intervals coinciding with the work of the stock exchanges of the United States, Europe and the Asia-Pacific Region. Traders pay special attention to them, since the trends of national currencies and the market activity of trading are directly dependent on the working hours of these platforms.
Trend, flat, tilt, "Night trading"
Trend is a directional movement of quotes, in which new extremes (minimums or maximums) are constantly reached.
Flat (saw) - sideways price movement with a constant repetition of coinciding local highs and lows.
Tilt – a state of panic, expressed in the fear of opening new positions, the lack of the possibility of objective market forecasting, which arose against the background of significant losses.
"Night trading" - deals in the "Asian" session.
"Trading on news"
" Trading on news " – opening positions during the release of these economic indicators or speeches of significant government officials, political events.
Open Interest – the number of open and active options collected by the expiration time.
Synthetic position – transactions with an underlying asset and an option that "mimic" other instruments, in particular a bond or orders of the type stop loss, take profit.
Bonus option is a contract under which a loss is not deducted from the client's account in case of a negative outcome, and a bonus is accrued if the forecast is correct. It is issued by the broker as a bonus, has a fixed investment size and a limited amount. Sometimes a part of the positions that have already gone to a loss is returned to the client in the form of bonus options.
Arbitrage – purchase and simultaneous sale of options of the same type from different brokers, with the goal is to get a guaranteed profit.
Correlation is the degree of interconnectedness of the movements of various assets that belong to the same type. For example, the main currency pairs with US dollar in the base, precious metals, oil and derivative products (fuel oil), etc.
Technical analysis-price movement forecast based on technical readings indicators, geometric constructions or combinations "japanese candlesticks"
Fundamental analysis-forecasting based on economic indicators and political events.