What is Binary Option ?

 The main two types that are available in Binary Option are asset-or-nothing and cash-or-nothing options. The common feature in both these options is that they give a fixed amount as payouts to the trader in case the condition is met and the event is executed before expiration. The ‘all-or-nothing’ option is another name for Binary options. Binary option is quite different from the traditional options under which the proportional amount is paid according to the difference between the strike price and the actual market price of the security held at the point of expiration. This is the reason why most binary options are traded as European-style options which means that they are exercised only at the date of their expiration. 

The Mathematics Involved In a Binary Option:

As mentioned, asset-or-nothing and cash-or-nothing options are the two types of Binary options. At the expiration date, if the option traded is in-the-money, then either a fixed cash amount or a fixed amount of the underlying asset is paid. In some trades in which asset-or-nothing options are taken, they are settled as per the cash value of the script being traded in the option. On the other hand, if this is not in-the-money, then the option will expire without any worth. Trading in in-the-money refers to trading on the price of the security that is up and above the strike price during a call, or trading on a price that is lower than the strike price during the put-of-expiration. These are very similar to the digital options. In digital options, trade is carried out primarily in foreign exchange.

Consider the example where you buy cash-or-nothing binary option of XYZ stock whose strike price is $50 and the payout amount is $250. Now, if this stock is traded at or even above $50 at expiration date, you will get $250. On the other hand, if XYZ is traded below $50, you will get nothing. Now, consider the traditional option in the same scenario. If the stock was trading for $51, you will get $100 and if the price is $52.50, then you will get $250. A huge number of factors influence the amount that is received in case of traditional options. The amount of payouts is directly proportional to the stock price whereas in case of binary options, the amount of payout is certain. 

The main reason for these options to gain popularity is that they are lot easier to price than the traditional options which follow the American-style options. It is quite easy to price binary options. The popular Black-Scholes pricing models can be used for the same. The degree of change or variability is greater in case of American options, since there is an option of early exercise.

Although it is always better to know about various types of options available, it is equally advisable to trade in small quantities in each of these options until you clearly understand and become familiar with each of their features and peculiarities.