Binary options are different from the traditional options in many ways. In general, binary options are built over traditional options, but binary options are more simple for the traders to execute transactions than the traditional options.
However, both binary options and traditional options are derivatives. It means that the value of these options is derived from some other assets. Traditional options are known to be the actual options and these are bought or sold at their strike prices. The much of the traditional option buying or selling strategy involves either exercising the options or allowed them to expire.
Most traditional options are generally traded on official markets and exchanges with standardized contracts. The clearing houses settle and supervise transactions of traditional options. On the other hand, binary options are traded in very few numbers of exchanges. The binary options are traded over-the-counter between two private parties, generally.
In binary options trading, the actual assets are not bought or sold, but the assets are used only as a benchmark to determine whether the contract will expire in-the-money or out-of-the-money. The underlying asset can be used as a virtual alternative and the correct predictions of their market prices will determine whether a trader will make profits or suffer losses. However, nearly anything could serve the purpose an underlying asset, and even traditional assets can be utilized as binary options.
Purchasing a binary option means that the trader is choosing an underlying asset and will predict whether its value will increase or decrease in the market, before the contract expires. The investor will earn a fixed return on his investment, if his predictions are correct at the contract expiry. Thus, he will receive a fixed payout which is called in-the-money. But if the prediction was wrong, he will suffer a fixed loss, which is called the out-of-the-money.
However, in case of a traditional option, the situation is quite different and a trader needs to purchase an option and needs to observe the market conditions on a regular basis to decide whether they will buy or sell the asset to be in the profitable condition.
Differences in Profitability
Moreover, in binary options, the earning potentials as well as chances of loss are fixed, whereas in traditional options, the level of the profit or loss depends upon the market movements of the underlying assets. Thus, in traditional options, the profit or loss is not fixed and cannot pre-estimate the level of loss or profit one may undergo in the market. While in case of binary option trading, a trader can be aware with the profit and loss potentials before investing in particular assets.
Binary options are more preferable to the traders, as it’s simple to execute trades in many aspects. In general, traditional options may come with variable contract lengths. At the same time, traditional options can be executed anytime during the contract period. On the other hand, binary options have contract lengths and can be exercised normally around one hour.