BINARY OPTIONS EXPLAINED

A Binary Option is more like a wager with a bookie than an investment tool. Nevertheless, binaries are advertised as a method for traders/investors to make money from a correct prediction on the future price of a stock-market index, commodity, or currency pair.
The payoff is all or nothing, but the payoff is too small.
The typical bet with a bookmaker requires the bettor to risk $55 for the chance to win $50.
That represents a payoff of 91% ($50 ÷ $55).  The best payoff I could find for binary option trading platforms is 85% (for some trades), and other platforms offer much lower payoffs.
From my perspective, betting on a football game is similar to buying a binary option. If you want to wager that your favorite team will defeat (after adjusting the final score for the point spread) its main rival, you can buy a call option on your team.
·         It your team wins (after accounting for the point spread), the option is "in the money" and the bookie owes you $50.
·         It your team loses, the option is "out of the money" and you owe the bookie $55.?
BINARY OPTIONS ARE EUROPEAN STYLE AND THAT MEANS
·         They cannot be exercised before expiration arrives (i.e., until the game has ended). 
·         They are settled in cash.
That is all there is to a binary option. Pretty simple stuff.
However, some trading platforms (the online website where binary options are traded) accommodate traders who require simplicity and do not allow binary options to be sold. By offering a binary option on both the "over" (the stock price will be equal to, or above, the specified price at the cutoff time) and the "under" (the stock price will be below the specified price at the cutoff time), there is no need to sell binary options.
Binary Options -- compared with stock options -- are probably easier for some traders to understand. And that's not good for inexperienced traders who tend to trade first and ask questions later.

NAKED OPTIONS AND RISK

When you anticipate that a stock (or index) will undergo a bullish or bearish price change, there are several (very basic), limited-risk, option strategies that you can adopt. These involve buying option premium.
·         Buy calls or call spreads when bullish.
·         Buy puts or put spreads when bearish.
The more experienced trader may also want to consider selling option premium in order to collect time decay (Theta is one of the Greeks that helps traders measure and manage risk).
·         Sell call spreads when bearish.
·         Sell put spreads when bullish.
·         Sell naked (cash secured) puts when bullish -- but only when you are willing to own shares of the underlying stock.
NOTE: The more sophisticated reader knows that buying a call spread and selling a put spread are equivalent positions (with essentially identical profit and loss parameters) when the underlying asset, strike prices, and expiration are identical.
Likewise, selling a call spread and buying a put spread are equivalent positions. 
Selling naked (unhedged) call options is considered to be too risky for most investors for two very sound reasons:
1.    The sum at risk is theoretically unlimited, and too many inexperienced investors destroy their trading accounts when adopting this strategy. Thus, very few brokers allow their inexperienced traders to sell naked call options. It is just as easy to go broke when selling naked put options, even though most brokers allow their customers to adopt this strategy.
 2.    Careful, skilled risk management is mandatory. It is very difficult for the novice trader to realize how unprepared he/she is to handle the risk associated with being naked short call options as the price of the underlying asset rises day after day.
Advice: If selling naked options is attractive to you (I shudder), please be certain that you sell an appropriate quantity of option contracts. Unexpected market events occur far more often than statistics predict -- and you must never own a position so large that it can jeopardize your entire brokerage account when one of those events does occur.
P/L Graphs illustrate Ultimate Risk
Buying options: Gains are unlimited whiles losses are limited to the cost of the options bought.
Risk Graphs: Buying calls and buying puts.
Buying spreads: Both profits and losses are limited, but the potential loss is reduced when compared with the strategy of buying options.
Risk Graphs: Buy call spread;  buy put spread.
Selling spreads: Selling call spreads;  selling put spreads.
Naked Options :  Selling naked calls;  selling naked puts.

MORE IRON CONDOR BASICS

Opening and Closing the Position
USEFUL TERMINOLOGY
When you own an iron condor position, there are four different options in the position: It is important to describe a position because it is far too easy to enter a trade order incorrectly and therefore you must be able to tell your broker which specific options to buy and sell. There is more than one way to accomplish that:
An iron condor position consists of two call options and two put options.
·         You can describe the put portion of the iron condor as follows:
·         You sold a put spread. 
·         You own a put credit spread.
·         You own a bullish put spread.
·         Each of these terms describes a position where you bought a less expensive, farther out-of-the-money put option and sold another put  option (same expiration and same underlying asset) that is more expensive and less far out of the money. You collected cash when trading these two different put options.
·         You can describe the call portion of the iron condor as follows:
1.       You sold a call spread. 
2.      You own a call credit spread.
3.      You own a bearish call spread.
Each of these terms describes a position where you bought a less expensive, farther out-of-the-money call option and sold another call option with the same expiration, on the same underlying asset and which is more expensive and less far out of the money. You collected cash when trading these two different call options.
 The most efficient method for entering an order to trade an iron condor is to find your broker's method for trading iron condors on their trading platform. Call customer service if you have any difficulty. Your plan is to enter a single order with the following information:
·         The specific options that you plan to buy and sell
·         The quantity of each option to trade. It should be the same number for each of the four options
·         The minimum net cash credit (that is the limit price, making this a 'limit order') that you want to collect when trading one-lot of each of the four options. Never enter a market order.
EXAMPLE: 
Sell 5 XYZ Nov 100 calls
Buy 5 XYZ Nov 110 calls
Sell 5 XYZ Nov 80 puts
Buy 5 XYZ Nov 70 puts
·         Never indicate the price at which you prefer to buy or sell any of the individual option because the only number that matters is the total cash that you want to collect when trading a 1-lot of each option. Always enter an order stating the minimum price (premium) that you will accept when entering an order that nets a cash credit, and a maximum acceptable price when paying cash. Never enter a market order. Never enter a market order. Never enter a market order.

PIN RISK

AN EXPIRATION CONCERN
Option sellers who hold their short positions until they expire understand the basics: An option owner has three choices. As a result, the option seller can expect:
·         The option owner to exercise his/her rights and (as the option seller) to be assigned an exercise notice whenever the option is in the money when expiration arrives.
·         To see all out-of-the-money options expire worthless.
The astute reader may ask what happens when the stock closes exactly at the strike price on expiration Friday.
When that happens the stock is said to be “pinned” to the strike and it represents uncertainty for the option seller. Note that the option owner has no such uncertainty because he/she has the decision-making power and may exercise the options or allow them to expire worthless. The option seller (who does not cover the short option) must wait for the option owner's decision.
That is where uncertainty (risk) comes into play.
Most of the time when the stock is pinned to the strike price, the person who owns the option chooses not to exercise and the option expires worthless. However, there is times when the option owner must exercise in order to maintain a long (or short) equity position in his/her portfolio. In addition, market makers often exercise ATM options at expiration in order to remove all risk of owning positions that are too long or too short. It is acceptable for any big trader to be short 10,000 shares of stock, hoping for a decline -- as long as he/she owns 100 calls to mitigate upside risk. When the stock get pinned to the strike price of those 100 options, the trader must exercise all 100 calls to cover the short stock position.
That trader cannot afford to take the risk associated with holding the short position over the weekend. These situations are not rare, so do not be surprised when you are assigned an exercise notice on an option that you thought would expire worthless.

THE BID-ASK SPREAD

GOOD TRADES AT FAIR PRICES

Your first trade can be a frightening experience, regardless of what you are trading. Until that first trade is behind you, the education process has been theoretical -- with nothing at risk. Pulling the trigger on that first order changes the game. There are two new things in your life: the possibility of earning a profit and the possibility of incurring a loss.

The information in this article is designed to help you avoid getting ripped off.
FUNDAMENTAL TRUTH: The transaction price is very important to your long-term success. The one exception is for the long-term trader who tends to hold positions for years, if not decades. As an option trader, your holding period tends to be short (few days to a few months, and each transaction represents an opportunity to lose money (i.e., by paying too much).
WHAT A TRADER SEES
When ready to place an order, you see "the market" for the options That market consists of a bid price and an ask price. If you enter a "market order", then -- in theory:
When you are a buyer, you pay the lowest price that anyone is willing to collect when selling the option.
When you are a seller, you collect the highest price that anyone is willing to pay when buying the option.
However, it does not work that way in today's computerized marketplace. The broker's software is designed to find the lowest or highest "published price" for the option. Translation: The program is not designed to negotiate prices. It merely finds the best available price and executes your order. If someone is willing to sell at a lower price -- but does not advertise (i.e., publish) that price, then your market order cannot find that lower price and you will pay the lowest published ask.
For example, one market maker may publish a bid price of $1.20 and an ask price of $1.40. For this discussion, let's assume that this market maker represents both the highest current bid and the lowest current offer at the time your market order reaches the floor of the exchange. When that happens you will pay $1.40 when buying and collect $1.20 when selling.
Notice that it does not pay for this market maker to bid any higher (nor offer to sell at any lower price) because the computerized program is designed to pay his/her prices (unless another trader publishes (i.e., displays) a better price.

SAFELY INVESTING FOR THE LONG TERM

When markets decline, and especially when the decline is deep enough to frighten a substantial number of investors, put options become much-desired commodities and prices soar. This price change comes from an increase in the implied volatility.
The conservative, well-prepared, investor understands risk management and has some method in place that cushions his/her net worth against a stock market debacle.
Those investors never panic and buy/sell decisions are made on their merits, and never out of fear. When they want to own put options -- or adopt a different portfolio management technique -- they already own them as part of their ongoing strategy. There is no need to pay up for options just because unprepared investors (and speculators) drive prices higher.
I absolutely believe that stocks are the best game in town. I don’t think there is a better way for the average investor to grow their wealth. However, this is called investing and the price of admission is gut wrenching drawdowns and sometimes years and years with nothing to show for it. If you can accept that this is the way things work, you can be an enormously successful investor.
The majority of investors tend to remain 100% bullish at all times. That investment philosophy can be successful for people who understand how the market works. Such investors invest in risk management ideas that limit the size of any drawdown (i.e., they do not lose so much money that they feel a need to sell everything in a panic).
This allows them to remain invested and to participate in all bullish markets.

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USING POSITIVE THETA STRATEGIES WHEN BULLISH OR BEARISH

COLLECT  THETA AND EXPRESS A MARKET BIAS
MARKET-NEUTRAL STRATEGIES earn a profit when time passes and the "magic" of time decay (Theta) does its thing. Of course it is not as simple as opening a position and waiting for the profits to accumulate. There is always the possibility of a profit-destroying price change in the underlying stock or index.
Nevertheless, these strategies work well when the markets trade within a narrow price range. The beautiful characteristic of these versatile option strategies is that they can be used by the bullish or bearish investor as well as by the market-neutral trader.
LET'S EXAMINE THREE STRATEGIES.
CALENDAR SPREAD
ABCD is currently trading at $65 per share. Believing that the stock price will rally towards $70 as the December 18, 2015 options expiration date approaches, you buy an out-of-the-money calendar spread.
Traditionally, the calendar is used by traders who believe that the stock price will remain near $65 when a specified expiration date arrives.
But there is no reason why it cannot be used by traders who believe that the stock price will differ at expiration. One advantage of using the OTM calendar spread is that it is less expensive than an ATM (at the money) spread.
Example:
     Buy 6 ABCD Jan 15 '16 70 calls
     Sell 6 ABCD Dec 18 '16 70 calls
As times passes and the stock moves towards $70 per share, the position becomes more valuable and you earn a profit. That profit is maximized if the stock is almost exactly $70 per share on Dec 18, 2015. At that time (or earlier if you wisely do not attempt to earn the maximum theoretical profit) you close the position by selling the calendar spread. 
If the stock price does not conform to your expectations, then the spread will lose value as the December calls expire (and become worthless).
You can keep your Jan calls, hoping for a miracle, but it is often wise to sell the call and recover some of the cost of buying the spread.
NOTE: One factor that affects profitability is volatility. When implied volatility is relatively high, the profits are even larger than anticipated. When implied volatility is low, the profits are reduced.

DOES THE REWARD JUSTIFY THE RISK?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RISK MANAGEMENT FOR THE NEWER TRADER

BUYING OPTIONS AND PREDICTING MARKET DIRECTION
Newer option traders tend to adopt the strategy of buying calls when they are bullish and puts when they are bearish.
It is very easy to buy some options based on your market savvy. In other words, you -- like the majority of new investors -- probably believe that the trade will be profitable because you believe that the stock price will behave as you predict.
That is based on the belief that you have a talent for stock picking and timing the market.
Despite a ton of data to the contrary (Numerous available data sources illustrate that individual investors perform far worse than the market averages when making buy/sell decisions) most still believe that they are not average investors and have the ability to beat the market.
RISK VS. REWARD
Those beliefs often lead to unwise investment decisions. That brings up the topic: How much money can you afford to risk when making investment decisions based on your ability to know what the future holds?
The more difficult questions are:
·         Can you estimate the probability of earning a profit from a given trade?
·         How does the potential profit compare with the money at risk?
EXAMPLE
The inexperienced option trader may look at a RS 40 stock, decide that the price is heading higher and seeing that the two-month option with a RS45 strike price costs 'only' RS0.15 (that's RS15 per contract), decides to invest RS75 by buying 5 contracts.
ANALYSIS OF THE TRADE
The risk is only RS75, so at first glance this seems to be an acceptable trade. After all, the potential gain is theoretically unlimited and the maximum loss is just RS75.
However, that is not the whole story. This is a stock whose price fluctuations are tiny. Translation: this is a non-volatile stock. In fact, over the past couple of years, the average daily price change is only 5-cents per share. The probability that the price can rally far enough in 45 trading days to turn this investment profitable is less than 1%. In other words, the likelihood of earning any profit from this trade is dismal and the most likely outcome is a 100% loss.