A binary option is quite different from a traditional option. With a binary option, there are only two possible outcomes: you either “win” and receive a predetermined reward or you lose and receive nothing.
Example:
You purchase a binary option for 5 USD, that states that if the market price on NYSE for 1 A-class share in Company XYZ is over 100 USD at 12:00 o clock EST today, you get paid 50 USD.
Binary options normally have a very short lifespan (some will expire within 1 minute after purchase) but there are exceptions. Binary options with a very short life span are usually purchased by speculators rather than investors. Binary options has also been likened to a type of gambling, and in some jurisdictions they are regulated by gambling laws rather than securities law or similar.
One of the major appeals with the binary option is that you can purchase a binary option that gives you a very big payout (in relation to the purchase price) if it pays out.
A binary option can be based on virtually anything, including stock prices, stock option prices, indices, commodities, and currencies. For unclear reasons, binary options based on currency prices are commonly referred to as “digital options” rather than binary options, even though they aren’t more “digital” than any other binary option.
It should be noted that the payout of a binary option doesn’t have to be cash. There are binary options available where the reward is something else, e.g. ownership of a stock or a stock option. Always check the binary option contract carefully before purchasing a binary option, since they aren’t standardized.
Exchange-traded binary options
In 2008, the Securities and Exchange Commission in the United States made it legal for exchanges in the U.S. to list cash-or-nothing binary options. The American Stock Exchange (now NYSE MKT LLC) listed their first European cash-or-nothing binary options in May 2008. Another early adopter was the Chicago Board Options Exchange.
Exchange-traded binary options are standardized.