Traditional options are conventional options trades that take place on the options markets and trading platforms, which all go to the Chicago Board Options Exchange (CBOE) for settlement. The commonest example of traditional options is the plain vanilla options, as this is seen as the simplest traditional option to trade on the CBOE.
Binary options are also known as fixed return options or digital options, and refer to the “all or none” types of trades where traders can bet and profit on one out of two possible trade outcomes for each type of trade.
Since both types of options are available for trading as financial instruments, it is possible that traders who are new to the markets may mistake one for the other. In this article, we will try to look at binary options versus traditional options with a view to correcting any misconceptions that may occur and clearly distinguishing one from the other so that traders encountering these two terms are not confused.
Binary Options vs Traditional Options: How are they similar to each other?
Binary options and traditional options are similar in a number of ways. They operate on the principle of trades that have a settlement price (strike price) and an established expiry time/date which is decided before the trade entry. All options trades, be it binary or traditional must expire at some point after which settlement takes place.
Another area of similarity is in the underlying assets that can be traded in both markets. Just as traders can trade binary options on stocks, commodities, stock indices and currencies, traditional options traders can do same too. The asset types traded on both options markets are similar.
Binary Options vs Traditional Options: How do they differ from each other?
One of the primary differences between binary options and traditional options is in the trade structure. Binary options are by their nature, structured to be very simple and uncomplicated. In binary options, traders are betting on one of two possible outcomes in a trade. Traditional options are much more complex in nature. In traditional options, there are several ways of trading and profiting from the markets that do not fit the all or none nature of the binary options market. It does not matter what trade types are used for trades in the market; binary options trades will always have one of two outcomes as the eventual result of the trade.
Another area where both types of options differ is in how traders can opt to end trades. Binary options are known as fixed return options because all trades must get to the expiry time/date before the outcome is known. For traditional options, it is possible for traders to close out trades before expiry.
How about the trade obligations on traders of both sets of options? Traditional options do not obligate the trader to exercise or buy back the option once the trade expires. Binary options trades are obligated to exercise the options they trade when those options expire.
The traditional options market employs a special price quotation system which shows quotes on both sides as well as the month of commencement of the option. The binary options market has no such complex price quotation systems, as traders can use the market price of the assets to evaluate the performance of their trades.
Certain trade types in the traditional options market are used or the purpose of hedging trades in other markets. It is possible to use a covered trade type outcome in the traditional market to protect against losses incurred on the asset in that asset’s traditional marketplace. Binary options do not fit the bill and cannot be used for hedging purposes.
The traditional options market is more risky than the binary options market. There are stiff leverage and margin requirements, larger commissions to pay and trade losses can have very steep implications on the account as trade positions are much larger in the traditional options market than in the binary options market. The risk in binary options is much less; traders do not have to contend with issues like leverage, margin or commissions. In addition, the feature that displays payouts for trades before execution allows binary options traders to evaluate the profit:loss potential of their trades before they commit funds to it. This enhances the reduced risk nature of the binary options market.
With this article, we hope that the confusion that exists in the minds of traders about traditional and binary options would have been cleared up.