How to Understand Binary Options
A binary option is a type of option where the trader takes a yes or no position on the price of a financial asset, and the resulting payoff is all or nothing. Because of this characteristic, binary options can be easier to understand and trade than traditional options.
Binary options are cash-settled as European-style options, meaning they can be exercised only on the expiration date. If at expiration the option settles "in the money," the buyer or seller of the option receives a pre-specified amount of money. Similarly, if the option settles "out of the money," the buyer or seller receives nothing. This allows for a known upside (gain) or downside (loss) risk assessment. Unlike traditional options, a binary option provides full payout no matter how far the asset price settles above or below the "strike" (or target) price.
Despite the term "all or nothing," depending on the actual trading platform, "nothing" can actually mean "something." This means that at expiration the owner of the option may actually get a certain payout even if the option expired "out of the money".
Very often you may encounter binary options under another name. In the foreign exchange market binary options are known as digital options.