INVESTOPEDIA EXPLAINS 'BINARY OPTION'

A type of option in which the payoff is patterned to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money. The success of a binary option is thus pin-pointed on a yes/no proposition, hence “binary”. A binary option automatically exercises, meaning the option holder does not have the choice to buy or sell the underlying asset.

Investors may find binary options attractive because of their apparent simplicity, especially since  the investor must essentially only guess whether something specific will or will not happen. For example, a binary option may be as simple as whether the share price of ABC Company will be above $25 on November 22^nd at 10:45 am. If ABC’s share price is $27 at the appointed time, the option automatically exercises and the option holder gets a preset amount of cash.

Binary options are obviously different from vanilla options. They are occasionally traded on platforms regulated by the SEC and other regulatory agencies, but are most likely traded over the Internet on platforms existing outside of regulations. Because these platforms operate outside of regulations, investors are at greater risk of fraud. For example, a binary options trading platform may need the investor to lodge in a sum of money to purchase the option. If the option expires out-of-the-money, meaning the investor chose the wrong proposition, the trading platform may take the whole sum of deposited money with no refund provided.