Binary options are usually referred to the Forex market, as 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 establishes the right, but not the obligation, of the client to make a transaction under previously agreed conditions. The practice of applying this definition in binary contracts is absent, it is more clearly disclosed in vanilla options.
The 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, at the end 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 the event of a rejection (negative outcome).
The premium in binary options is the amount of the payout if one of the two conditions is correctly predicted, whereas in vanilla options, the premium is the value of the contract.
Binary options differ from vanilla options by the ability to combine several consecutive conditions in one trade, which follow each other and are tied to certain time intervals. Such composite instruments are called express options.
Call, Put, ATM, OTM, ITM
The largest number of matches in terminology with a vanilla option has a binary contract Above/Below (Call/Put):
- Call means the 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 expiration of the contract.
- At-The-Money (ATM) – the current tick-to-tick 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) – asset quotes are in the correct direction of the forecast.
The latter two definitions are actively used in the "American" type of contract, which implies the possibility to change the terms of the transaction. For example, in the case of early closing of an option:
- 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 payouts in the event of an "At-The-Money"situation.
Return, Strike price, ask, bid, spread
Expired OTM binary options can have a degree of protection (refund, compensation) – the percentage of the lost bet that the broker returns to the client's account.
The value of the price at the time of expiration, 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 – the price level that will be fixed when the movement is predicted to be "Higher".»;
- bid – the entry level accepted when calculating the forecast "Lower"at the time of expiration of the terms of the transaction.
The difference (distance) between these prices is called the 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 contract with an unusual underlying asset. They are based on any conditions that imply a double outcome, for example:
- weather, crop/drought, volatility, random random number generator indexes, winning / losing any kind of contest or political election outcome, etc
Limit (pending) option order
A limit (deferred) option order is a type of option with pre-agreed terms and execution time that takes effect only if the asset's quotes reach a certain (deferred) price level.
"American", "European", "Asian" sessions
"American", "European", "Asian" sessions – time intervals that coincide 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 – a directional movement of quotes, in which new extremes (lows or highs) are constantly reached.
Flat (saw) – a 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 ability to objectively predict the market, which arose against the background of significant losses.
"Night trading" - deals in the "Asian" session.
"Trading on the news»
"Trading on the 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-deals with the underlying asset and option that "simulate" other instruments, in particular a bond or stop-loss or take-profit orders.
A bonus option is a contract under which a loss is not deducted from the client's account in the event of a negative outcome, but a bonus is accrued if the forecast is correct. Issued by the broker as a bonus, it has a fixed investment size and a limited amount. Sometimes the client is returned some of the positions that have already gone to a loss in the form of bonus options.
Arbitrage-the purchase and simultaneous sale of options of the same type from different brokers, in order to obtain a guaranteed profit.
Correlation – the degree of interconnectedness of the movements of different assets that belong to the same type. For example, the main currency pairs with the US dollar in the base, precious metals, oil and derivatives (fuel oil) , etc.
Technical analysis – a forecast of price movement based on the readings of technical indicators, geometric constructions or combinations of " Japanese candlesticks»
Fundamental analysis-forecasting based on economic indicators and political events.
Martingale is a trading strategy that consists in increasing the size of the investment in the option with each new loss.