Understanding Math behind Binary Options
Trading stocks has always been criticized for being a gamble. It makes some sense. Even if you dissect every investment with scientific precision, you will still encounter myriads of different variables that can come into play and rob you of the much deserved success. Keeping this in mind, it is easy to see the reason why binary options, which made trading stocks simple to the degree where they barely resemble traditional trading options, are gaining so much popularity. But what exactly are those binary options, and what is the math behind them?
Binary Options 101
In the IT language, the word “binary” describes something which can have only two states – 0 and 1. In the world of stocks, the same word describes the trade option which can have the same two outcomes – you either lose, or you win. Namely, when buying a binary option you make an assumption whether the price of some asset will increase or decrease over some specified period of time and bet $100 that you guessed correctly. Depending on the outcome you either win back your bet, or you lose almost $100.
Understanding the Prices
Of course, those were only the fundamentals of binary options in a nutshell. Fully understanding this discipline, however, requires further exploration of two of their most basic terms.
- Strike price – This is the price at which some stock can be exercised by specific date. If you bet correctly, and the price at the expiration date is higher than the given strike price you will get a fixed return, regardless of the magnitude of the price movement.
- Price of a binary option – The price of some binary option is determined by market’s perception of probability of some event happening. For example, if the price of some binary option is $96 that means that 96% of the market means that the contract will end up making money.
Essentially, if you bet that some stock will reach the strike price of $2000 for the trading price of 30$, and that stock exceeds the price (whether for $1 or $10,000), by the end of day, you will earn $70.
Improving the Odds
Although this concept sounds very simple, trading binary options is one of those disciplines which are easy to understand, but very hard to master. Until you become experienced enough consider using some of these options to keep your winning ratio above 60%:
- Use the “trading bots” – These applications will calculate market signals (advanced algorithms), which will, in turn let you know when some stock, currency, or a commodity will go up or down. If used correctly, they can give you an edge while trading.
- Choose the right brokerage – There are brokers, and there are brokers. Huge part of your eventual success may lie in choosing the right one. So, when you are opening a brokerage account always opt for a reliable company like 24options, which will provide you with secure trade environment and even throw in a few bonuses to help you along the way.
- Manage the money – In other words, divide 100 by the number of lost trades you had in the last 100 tries. For example, if you lost 30% of your bets, the number you will get is 3%, meaning that you should not bet more than 3% in the next trade. To be even safer, you can even bet less. You can of course, also try diversifying the portfolio and compensating the calculated loss with the return from some riskier investments.
As we can see, binary options are both simple enough to attract inexperienced weekend traders, and challenging enough to get even the long-time stock traders hooked. The 50:50 odds of winning may actually be the fairest chance you can ever get on the stock market, so if you are ready to be patient and careful, we say it is worth a try.