A binary option (also known as an all or nothing option) is an option where a fixed payout is made under conditions defined in the option's contract. These conditions are defined in terms of either of the following:
One or two American barriers, i.e., they can be touched at any time during the option's lifetime.
The fixed payout is made on the option's delivery date in the base currency, and is based on whether the option is on the money or not, not by how much it is in the money.
One or two European barriers.
That is, it only matters where the underlying asset is in relation to the barrier (above the barrier, below the barrier, or within a defined range) on the option's expiry date.
If on the expiry date:
The defined condition is met (the option expires in the money), the fixed payout is made on the option's delivery date in the base currency.
The defined condition is not met (it expires out of the money), no payout is made.
Why buy a binary option?
Binary options are ideal if you have a view on the expected direction of the spot movement, rather than a view on by how far it will move in that direction.
If you use European barriers, then you are speculating on the level of the spot on a specific date, in this case, the expiry date. If you win the bet, you receive a predefined amount of money. If you lose the bet, your maximum loss is the premium.
The main use of a binary option is by option traders as part of their portfolio management and to hedge the risks of other exotic options.
Types of binary options
You can create the following binary options:
European Binary with American Knock Out
European Binary with American Knock In
European Binary with Double American Knock Out
American One Touch with American Knock Out
American No Touch with American Knock In