At first glance, binary options may be easily confused with foreign exchange (forex) transactions because currency is often the underlying asset used for these options. However, binary options and forex trades are two distinct financial products with a number of important differences. Binary options are often more flexible than currency transactions, and the potential profit can be much higher for options than for currency over the same period of time.
About the Forex Market
The forex market is actually a group of regional markets that operate in locations around the world. The most popular of these markets are in The United States, Europe, Japan and Australia. The purpose of the forex is to provide central banks, investment firms and individual traders with a forum where the value of world currencies may be tracked and where one currency may be exchanged for another.
Collectively, the forex market is the largest financial market in the world. Somewhere between $1.5 trillion and $3.5 trillion of currency is traded on the forex every day. The values of the various world currencies are tracked through what are called currency pairs. One currency acts as a base unit by which a second currency can be compared. The most active currency pair is U.S. dollars and euros (USD/EUR), but other popular pairs include U.S. dollars and British pounds (USD/GBP), U.S. dollars and Australian dollars (USD/AUD) and euros and Japanese Yen (EUR/JPY).
Because forex markets are regional, at least one is open somewhere in the world at any given time of day. This allows investors to trade at all hours and even on Saturdays when the stock markets are closed. Because of this, currency pairs are often used as underlying assets for binary options.
About Binary Options
Binary options are a type of investment product that is easy to understand and simple to trade. The term used for these options refers to the fact that only two outcomes are possible: The investor either receives a fixed payout defined in the option contract or loses the initial investment, which is the purchase price of the option.
A binary option is a speculation on whether the value of an asset at the time of the option?s expiration will be higher or lower than it was when the option was opened. The asset could be anything that is traded on financial markets, including individual stocks, stock indices and commodities. However, foreign currency remains the most popular asset to use for these options.
The way that binary options work can be most effectively conveyed through an example. In this example, an investor believes that the euro will rise against the U.S. dollar by the same time tomorrow. Instead of going to a forex broker and exchanging U.S. dollars for euros, the investor can go to an options broker. The options broker will create a contract that expires at the same time tomorrow. This binding contract states that if the euro is higher against the dollar when the contract expires, then the broker will pay the investor a return on the investment. The payout depends on the amount invested. The broker determines that a 50 percent payout is appropriate for this particular option, and the investor purchases the option for $1,000. In this case, if the option closes in the money, then the investor will be paid $1,500. If the option closes out of the money, then the investor loses the $1,000 that was paid to purchase the option.
Advantages of Binary Options
Many investors consider binary options to be more advantageous than forex trades for several reasons. One important advantage is that binary options can be diversified across several different assets, across several classes of assets and even across different markets. Forex trades, of course, are limited to foreign currency.
Another advantage of binary options is that they do not require continuous research to maintain. Once an option is purchased, it can be tucked away and put out of mind until the expiration date. Forex trades are always open and do not close until an order to trade is issued by the investor. Determining the best time to close a forex trade can take hours of research each day the trade remains open.
One of the primary benefits of binary options is that it is easy to control losses and calculate profits with them. An investor always knows exactly how much he or she stands to lose on each option at the time it is purchased. Profits and losses on forex trades are open-ended because they are determined by how much a currency rises or falls against its base currency, which makes planning future trades extremely difficult.
Finally, investors may experience larger gains in a shorter time with binary options than with straight forex trades. The initial investment required for a forex trade can be much higher than the cost of a binary option for the same payout, and with a binary option, investors do not have to worry about making a margin call for an unexpected loss.
Source: http://msdscat.com/forex-versus-binary-options/
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