In finance, binary options are a type of option where the payoff is a fixed sum or nothing at all. These type of options are also called all-or-nothing options, digital options or ‘fixed return options’ (FROs).
There are two main types of binary options:
- cash-or-nothing binary option – these pay some fixed amount of cash if the option expires in-the-money
- asset-or-nothing binary option – these pay the value of the underlying security.
Let’s discuss this further with an example:
You purchase a binary option on a stock with a strike price $100 with a cash-or-nothing value of $500. If, at the maturity date of the binary option the value is $100 or greater, $500 is received. If the stock trades below $100 as of maturity, nothing is returned.
Check out what are binary options to find out more about binary options, brokers, strategies.
Are Binary Options Legal?
Absolutely legal, yes. In 2007 the Options Clearing Corporation suggested a rule change to allow cash-or-nothing binary options to be listed. In May 2007, the American Stock Exchange (Amex) launched exchange-traded European cash-or-nothing binary options and Chicago Options Exchange (CBOE) followed in June 2008.
The Amex exchange now offers binary options on some Exchange Traded Funds (ETFs) and a few highly liquid equities such as Citigroup and Google. Amex refers to these binary options as “Fixed Return Options” (FROs). Calls are called “finish high” and puts are “finish low”. In an effort to eliminate manipulation of markets, Amex FROs use a “settlement index” defined as a volume weighted average of trades on expiration day.
CBOE offers Binary Options on the S&P 500 (SPX traded as BSZ) index and CBOE Volatility Index (VIX traded as BVZ). Strikes are at 5-point intervals on BSZ and 1-point on BVZ.