What’s the Difference Between Traditional and Binary Options?

The popularity of binary options is growing fast since everyone is attracted to high profits they offer. Skillful traders can earn good money literally in minutes. This isn’t another trick to target naïve people but is a reality. However, not everyone familiar with this financial instrument knows that besides binary there are traditional options which are sometimes called vanilla options. In this article we’ll focus on the difference between these two option types rather than on each of them separately.

Traditional Option

This option type is basically a contract for future sale or purchase of an underlying asset. All characteristics of an option, including expiration time, are specified in this document. Traders don’t know in advance what profit or loss to expect because everything will depend on exercise price or when a contract gets cancelled.

Let’s consider an example to better understand the nature of traditional options. Suppose you expect company X share price to rise. Therefore, you buy an option with the corresponding underlying asset. Strike price of one share is $100, expiration is one week.

After one week is over, the company shares indeed become more expensive and their price is now $150 each. As a result, your profit is $50 ($150-$100). But options are traded through brokers and they take certain commission for their services. We assume commission is 10% of a contract amount and therefore deduct $10 from $50 to calculate net profit.

A less-favorable scenario, when trader’s forecast isn’t accurate, should also be considered. Let’s say stock price has declined to $95. This means that a trader has a $5 loss and in addition pays $10 commission. Overall, instead of making profit, trader has $15 loss.

Binary Options

Binary options are much more simple and convenient to trade. They are often referred to as financial bets, and they are really very similar to sports betting. Instead of worrying about what profit or loss they might have, traders know exactly how much they risk losing and can earn. Let’s consider the same example. All the characteristics of the contract are similar. If future share price at option expiry will increase at least by one cent, investors will be paid full amount of profit, which is usually 70-80% of contract size.

The main advantage of binary options is that the difference between strike and exercise prices is irrelevant. The only thing that matters is whether or not exercise price is higher or lower than strike price. But this binary options characteristic makes investors happy only when they receive profit. The problem is binary options expire out of the money even if market moves in different direction by at least one point. Usually loss is 100% of a contract amount. This is major threat when trading this financial instrument.

Differences

Their main difference is that one option type offers fixed profit and loss while the other doesn’t. But this isn’t their only difference. Binary options are much more affordable because today it’s possible to find brokers allowing $1 minimum trades and $10 minimum deposits. Meanwhile, traditional options traders need to invest much more and therefore, not everyone can afford trading this financial instrument.

Both option types have their own advantages – lower risks, the opportunity to earn high profit, etc. But all in all, binary options seem more attractive for a wide audience because they offer small investment opportunities, quick profit and convenience. However, there’s another benefit vanilla options give – the chance to close a trade prior to expiry. You can cancel vanilla option contract any time, whereas binary options brokers rarely grant this opportunity.

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