Digital Options – Tutorial & Brokers
Day trading digital options allows traders to take a straightforward yes/no position on commonly traded financial markets. It is perhaps little surprise then that these uncomplicated propositions are gaining popularity. This page will provide a definition for the four different types of digital options, before covering markets, benefits and risks, plus strategy and regulation.
What Are Digital Options?
Digital options rest on a single statement, meaning if you correctly speculate on a market event taking place, you turn a profit. However, predict the outcome incorrectly and you will lose your initial capital.
Let’s say the digital option statement reads ‘Dax 40 to finish up’. If you believe this to be true, you can buy the digital option. Alternatively, if you think this won’t happen, you can sell. A ‘call option’ gives the holder a right to buy and a ‘put option’ gives a trader the right to sell.
An attractive feature of trading digital options is the certain degree of flexibility. This is because you take a position based on an event taking place within a specific timeframe. However, you can also trade within that timeframe.
So, you could start trading on a one-hour digital option when there are just 15 minutes left until expiry. You will often find the pre-closed period for digital options is between 30 seconds and two minutes preceding expiry. However, this is dependant on both timeframe and instrument.
You will often see the price of digital options ranges from 0 to 100. This represents the probability the broker believes there is of the event happening. To make that decision, underlying market behaviour will be analysed and the length of time the digital option has until it expires, will be taken into account.
Quite simply, the closer the price is to 100, the greater chance the broker believes there is of the event occurring.
Returning to the Dax 40 example above, if the digital options statement were true (Dax finished up), the price would settle at 100. However, if it were not true, and it either finishes down or does not move, then your profit will depend on the amount per point you have wagered, as well as the difference between your opening price and the digital option’s closing price.
Note, pricing formulas may vary between providers.
You can break digital options into four distinct trade types:
- Ladder – You must decide whether the settlement price (reference price which decided whether you have won the digital option) will reach or exceed your chosen strike price (target price against which the digital option verdict is decided) when the digital option expires. Therefore, you would buy if you think the settlement price will exceed your settlement price. Alternatively, you would sell if you are of the opinion the settlement price will finish below your strike price.
- One Touch – Ladders and One Touch digital options trading is similar. With the latter, your trade is based on whether you believe the settlement price will hit your strike price before the digital option expires. If yes, you would buy. If no, you would sell.
- Up/Down – Up/Down digital options trading is slightly different. Usually, you will have just one strike price. This will be the preceding period’s close. You buy and sell based on whether you think the settlement price will finish at or above the last period’s close when the digital option expires.
- Range – Unlike Ladder and One Touch digital options, with Range digital options, you must decide whether the settlement price will close within a certain range when the digital option expires.
Trading digital options appeals partly because you can speculate on some of the world’s most active financial markets. For example, you can trade signals on indices, commodities and forex pairs. Below are just a few of the popularly traded instruments available.
- FTSE 100
- Dax 40
- Dow Jones Industrial Average
- Major currency pairs, including EUR/USD, GBP/USD, plus USD/JPY
- Gold, silver, and Crude Oil West Texas
Having said that, what you can day trade digital options on will depend on the broker you go to. However, as popularity for digital options increases, so will the choice of markets.
How To Trade Digital Options
Day trading on digital options is relatively straightforward. You need to follow just a few basic steps below to get set up and start speculating on financial markets.
Step 1 – Choose A Type
Choose between the four digital options types listed above. Also, choose between the listed expiry options.
Step 2 – Choose An Instrument
Pick a product/market, for example, the GBP/USD currency pair or the Dow Jones index. A useful tip would be to concentrate on a market you have a thorough understanding of. You may also want to consider how readily accessible relevant data is.
Step 3 – Choose A Strike Price
Look down the strike list and select a strike price. Do you want to buy or sell?
Step 4 – Practice On A Demo Account
Many of the top brokers offer traders the option to try their trading strategies on a demo account before investing. This is a useful strategy for minimising risk and is always advised before you put real money on a new financial instrument.
Step 5 – Enter Your Trade
Enter your trade size. When you do that, consider however much you stake as you could potentially lose all of this. Once you have done that, place your order on whether you think the event will occur (buy) or will not (sell).
Step 6 – Monitor
You can sit back and monitor your position. You should be able to follow your position by bringing up a chart. Also, you may have the ability to exit or to some extent, reduce your position size before the pre-closeout period. Hedging a digital option is possible with a call spread.
Why Trade Digital Options
There are a number of benefits to trading with digital options. These include:
- Timing – Short-term trading on digital options allows you to take positions on some of the world’s most influential markets with timeframes starting from as little as five minutes. This is ideal for active intraday traders.
- Simplicity – You don’t need to worry about a range of outcomes. You are simply concerned with a yes or no proposition.
- Accessibility – You may be able to benefit from the choice of a desktop or mobile-based platform. This could enable you to execute trades when you are on the move or on your way to work.
- Risk– Because you know how much you could potentially make or lose before you place your trade, you don’t need to worry about opening yourself up to substantial unknown losses.
- Charting – Some traders may worry they will have to sacrifice advanced charting features. However, many providers offer sophisticated and easy-to-use platforms with up to 100 indicators and drawing tools.
- Opportunities – You also have the ability to trade when markets are moving sideways. This could mean generating profits during periods of low volatility from less significant market shifts.
Despite the number of attractive benefits, there are also certain drawbacks and risks to trading with digital options. These include:
- Loss potential – Despite the limited risk, in periods of volatility, sharp market swings can still result in significant losses.
- Challenging odds – It is important to note the odds are often biased in the favour of the broker. So, an effective strategy will be required to generate consistent profits. Having said that, competition to win customers may improve odds somewhat.
- Complex risk prediction – As a result of trading on short timeframes, consistently predicting market moves can prove difficult.
- Limited trading tools – Although dependant on the digital options provider, you will often have access to fewer trading materials and analytical tools when compared to other trading products.
With a number of online day trading scams around, it’s important to check your product is legitimate and properly regulated. There will then be certain rules and regulations the digital options provider will need to adhere to.
In the UK, for example, you may want to check the broker is regulated by the Financial Conduct Authority (FCA).
Although the proposition may be simple, consistently being correct is not always straightforward. So, you will need to develop an intelligent strategy, considering the elements below.
Unlike spread betting and CFDs, you do not need to apply regular, trailing or guaranteed stop losses into your digital options trading plan. However, you do need some form of money management system.
One suggestion is not to stake more than a few percent of your account balance on a single trade. This will prevent you losing too much capital in a short space of time. Then when your strategy starts producing consistent results, you can increase your risk parameters.
Whilst some individuals concentrate on trading around news events, technical analysis may also improve your market prediction. So, check your provider offers a charting package with all the chart types and indicators you may want to use. As a result, you should be able to carefully analyse the instrument you are looking to trade.
One Hour Ladder Trade
Below is an example strategy for trading the GBP/USD currency pair. Let’s say you believe the pair will move higher once the US non-farm payrolls announcement is made at 13:30 GMT.
Also, let’s say that at 13:00 there is a one-hour digital option priced at around 10.8 on the sell side and 17.00 on the buy side, for a strike price of 1.1587500.
You think that by the digital option expiry time of 14:00, the price will have hit or exceeded the strike. So, you choose the buy price and fill in your order ticket.
Now you place a buy Ladder order with a size of 1:
Your trade size has a maximum profit potential of £83.00. This is because profit/loss = (settlement price – purchase price) x size. So, potential maximum profit = (100 – 17.0) x 1.
Your maximum potential loss is £17.00. This is because profit/loss = (settlement price – purchase price) x size. So, potential maximum loss = (0 – 17.0) x 1.
Now if the non-farm payrolls announcement is as you expected, you can monitor the market and collect your £83.00 profits when the expiry time is up.
For further guidance, see our strategy page.
Final Word on Digital Options
Trading digital options offers a straightforward means of speculating on popular financial markets. In addition, it comes with limited risk because you know how much you will lose before you take a position. Having said that, generating consistent profits will still require careful technical analysis and an effective strategy. Now that we’ve explained how digital binary options work, you’re ready to get trading with one of our recommended brokers.
How Do Digital Options Work?
Digital options work by paying out when a statement is true or false. For example, if a trader believes a stock will fall below $10 per share by the end of the day, they’ll buy a digital option for this statement. If the price dips below $10, they’ll receive a payoff/payout. If it does not, they’ll receive nothing.
Are Digital Options Halal?
Some Muslim traders believe digital options are not halal because of the similarities with gambling. However, this is open to personal interpretation. Muslim traders may want to seek advice from their religious leaders before investing.
Digital Options Vs Binary Options: What's The Difference?
Binary options and digital options are similar but have one key difference. Digital options provide traders with more variables to speculate on than binary options. While binary options work on a simple higher/lower statement, digital options can include by how much.
Are Digital Options American or European?
Digital options can be American or European depending on which type the trader wishes to open.