Binary Options: CBOE vs. Online Brokers

BinaryOptionsNow | Published on July 10, 2011 at 2:56 pm

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In order to deepen one’s understanding of binary option trading, it is important to discuss the differences between exchange-traded binary options and online or “retail” binary options.

The world’s largest binary options exchange today is The Chicago Board Options Exchange (CBOE) located in Chicago, Illinois, which was established in 1973 as the first US options exchange offering standardized, listed options mostly on stocks. The CBOE first offered binary option contracts for purchase on July 1, 2008 as a way for investors and traders to profit from their sentiment on the market direction of specific financial assets.

The CBOE’s new innovation in options trading was a big success and binary option trading quickly spread to include the over-the-counter binary options currently offered by online option brokers.

The binary options offered by the CBOE are quite different in structure than the ones that most online option brokers offer via their Web-based option trading platforms.

Here are a few notable differences:

Payout

The payout structure for CBOE binary options is set in a different manner than the payouts for most over-the-counter binary options. With CBOE options, the payout is fixed at $100 per contract and the price of the contract can vary from $1-$99 per contract.

So, if Trader A purchases 100 call binary option contracts on Google stock at $30 and the strike price is above the initial price at expiry time, he would receive a payout of $10,000, thus making $7,000 in profit.

Here’s the calculation:

Price: 100 contracts * $30 per contract = $3,000

Payout: 100 contracts * $100 per contract = $10,000

Profit: Payout $10,000 – Price $3,000 = $7,000

In contrast, most online binary option brokers set up their binary option contracts very differently. Instead of being charged per contract, traders are requested to choose an investment amount for each binary option contract and they are then guaranteed a specific return on that investment amount if they select the correct market direction for the underlying asset of the binary option contract they purchase.

Using the same data as in the example above, here’s how a binary option investment with an online binary option would take place: Trader A invests $10,000 in one call binary option contract on Google stock that pays out 70%. At expiry time, the stock’s strike price indeed finishes above the stock’s initial price at time of purchase so Trader A receives a payout of $7,000 on top of his investment of $10,000, thus making $7000 in profit.

Here’s the calculation:

Price: Investment amount $10,000

Payout: Investment amount $10,000 * Payout percentage 70% = $7,000

Profit: (Investment amount $10,000 + Payout $7,000) – Investment amount $10,000 = $7000

In the end, the amount of profit for both CBOE binary options and retail binary options in these examples is identical: $7000. The main difference is that the CBOE varies the prices for binary option contracts whereas online brokers tend to vary thepayout percentages instead.

All-or-nothing:

Binary options offered by the CBOE pay out a pre-determined fixed amount ($100) or nothing at all. So, if you’ve selected the correct market direction, you receive the option’s payout. However, if you’ve selected incorrectly, you receive zero in return and lose your entire investment amount.

In contrast, many online option brokers offer “insurance”, “protection” or “guaranteed return” rates of 10-15% for unsuccessful binary option investments. So, if you choose the right market direction for the underlying asset, you get the payout and if you choose the wrong direction, you get 10-15% of your investment refunded to you.

Liquidating before expiry

Another key difference between CBOE binary options and online binary options is that positions on CBOE binary options may always be closed out before the option’s expiry if the trader desires. Not all binary options provided by online operators can be closed out before expiry; in fact, most of them by default may not be closed out before expiry.

In order to close a binary position on a CBOE binary option, the trader must simply enter a buy or sell order (depending on whether a call or put option was purchased) and the option will be bought or sold at the current market price. Depending on the original price for the binary option contract, the trader can either profit and lose money when closing out the binary position before expiry.

Conclusion

All in all, the CBOE binary options and online binary options have more commonalities than differences as financial investment instruments. However, for option traders familiar with CBOE binary options, it’s important to clearly understand how online option broker’s binary option contracts are different in order to be able to maximize returns when trading online.

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