Binary Options Pricing
Understanding binary options pricing is a key step for beginners. This guide explains how binary options are priced, from fixed payouts to the 0 – 100 model. We also unpack other costs when trading binary options, from payment charges to early closure fees.
Binary Options Brokers
Binary Options Basics
Binary options are derivatives that can be traded on almost any asset or market. Investors speculate on whether the price of an asset will be higher or lower than the current price at expiry.
Binary options are also known as ‘all-or-nothing’ trades. This is because there are only two outcomes when the contract closes:
- You win and are rewarded with a fixed payout
- You lose and get nothing
How Much Can You Win?
There are two key binary options pricing structures to get your head around:
The percentage payout for a digital options contract will depend on three key factors: the asset (and its volatility), the length of the contract, and the broker in question.
Payouts usually vary between 75% and 95% of the initial capital staked. The moment you open the contract, the payout will be fixed.
For example, imagine that a contract has a payout of 88% and you decide to invest $1000. If you win, you will receive your initial investment back, plus the 88% payout. Therefore, your net profit is: $1000 * 0.88 = $880.
However if your prediction is incorrect, you will lose your initial investment, so you will be down -$1000.
This is the straightforward binary options pricing model found at most top brokers.
$0 To $100
One of the most popular US-regulated binary options brokers is Nadex. All the binary options trades on this exchange, plus some other platforms, expire with a worth of $0 or $100. This means that your potential profit will always be $100 minus your initial investment, while your potential loss will be your original investment.
The initial price of your investment is dependent on the volatility of the underlying asset and the length of the contract.
Nadex also gives users the option to exit a contract early. You can do this by closing your position at the current market price. Essentially, the price of the contract will vary over time. This is because the closer you are to the expiry time, the more information you will have, and thus you will be more likely to predict the outcome of the contract.
If the contract looks likely to win, then the price of the contract will rise (compared to the initial investment). If the opposite were to occur, a losing contract’s price would fall. Your profit or loss from exiting early would be the difference between the current market price and your original investment (minus any fees).
Importantly, the binary options pricing approach used should be visible on the brand’s website. Alternatively, head to our reviews.
How Do Binary Options Brokers Make Money?
A major factor towards the profitability of binary options brokers is the win percentage of their customers’ trades. Most retail investors make more losing trades than winning ones. Also, payouts are often less than 100% so traders need to be right more than 50% of the time. That means that overall, most traders are losing money, while binary options brokers are often profiting long-term.
However, failed trades are not the only way that binary options platforms make money:
Additional charges can include deposit and withdrawal fees, double-up fees, subscription charges, and currency conversion rates.
Deposit and/or withdrawal fees are relatively common. These can be either flat or percentage-based charges that are applied whenever a trader deposits or withdraws money from their brokerage account.
Binary options brokers may also charge subscription fees for premium tools. This can include access to market data, bots and trading signals. Fees may also be charged for features such as the double-up.
Currency conversion fees are another way brokerages can make money. This involves charging a fee every time you need to convert your money to the base currency of your binary options account (if it differs from your local currency).
Choosing A Low-Cost Binary Options Broker
When it comes to choosing a binary options broker, you will want to balance good payouts with low fees, as well as a transparent pricing structure. If a brokerage offers exceedingly good payouts, they may have hidden fees elsewhere. Conversely, binary options brokers with low fees may also offer lower payouts.
Here are a few questions to consider alongside the binary options pricing model:
- Is my strategy reliable? If so, should I aim for binary options brokers with high payouts?
- What features do I want access to? Will I be using signals and automated trading bots?
- What currency will I be trading in? Will I be converting currencies frequently?
- Will I be depositing and/or withdrawing regularly?
Valuing Binary Options
Valuation is a popular topic when it comes to regular options trading. You can also perform valuation calculations on digital options, particularly US variants. These pricing formulas will give you an estimate of the present value of binary options contracts.
Binomial Options Pricing Model
This approach is primarily used to value US-based options, which can usually be exited before the expiration date.
The binomial pricing system uses iteration to value a binary options contract at select points in time between the valuation date and the expiration date.
You assume that there are two possible outcomes for every node (time period), which consist of a move up or a move down from the previous node. This can quickly turn into a multi-period binomial tree of values that shows the path the price can take.
Each move is assigned a probability based on the research you have conducted on the market. This research can include recent news, market volatility, and historical trends. These probabilities don’t have to be the same for every period. For example, if your research suggests there is a high likelihood that an upwards trend is forming, you can assign higher move-up percentages for each successive node.
This process allows you to predict the value of the options contract at each period, which theoretically should indicate whether you should exit early or hold for longer.
The binomial model, while useful for American options, assumes that there are only two prices an options contract can move to between each node. This is untrue as they can move to any value within a range. The system is oversimplified, and incorrect predictions can lead to big deviations in your results.
Furthermore, a large amount of research needs to go into creating a strong model, which is infeasible for binary options contracts with short expiry times. Therefore the binomial model is only feasible for use with contracts lasting weeks or even months.
Final Word On Binary Options Pricing
Binary options pricing can be difficult to navigate, with platforms offering different payout structures and charging various fees. Fortunately, the top binary options brokers offer a straightforward, fixed payout and follow the all-or-nothing trading model. They also don’t charge for deposits and withdrawals.
Use our list of the top binary options brokers with low fees to get started.
How Does A Binary Options Broker Make Money?
Binary options brokers make money from the difference between their clients accumulated losses and the amount they pay out in winning trades. While payout percentages are often high, the number of consistently successful traders is relatively low. Some brands also have other revenue streams. These can include withdrawal fees and charges for accessing premium features, such as early closures.
What Is The Most Common Binary Options Pricing Model?
Most binary options brokers follow an all-or-nothing pricing model. This means traders will either win a fixed payout, such as 50% or 75% of their initial stake, or they will lose their original investment.
How Do You Price Or Value Binary Options?
Valuing binary options can be done in several ways. The most popular pricing models are the Binomial Option Pricing Model and the Black-Scholes Model. The binomial model is better for pricing American-style options, while the Black-Scholes model is better for European-style contracts.
Can Binary Options Be Profitable?
Yes, binary options can be profitable. Skilled traders can capitalize on the large payouts offered by online brokers. Use our guide to trading binary options to get started.
Can You Lose Money Trading Binary Options?
As with all types of trading, you are putting your capital at risk in search of profits. The upside to trading binary options is that you know exactly how much you can lose or win before opening the contract. This is baked into the binary options pricing model of most leading brands.