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The Differences Between Forex Binary Options and Vanilla Option

The Differences Between Forex Binary Options and Vanilla Option

There was a time when the term options referred to what is commonly called vanilla options. Over the past few years, there has been the evolution of binary options trading. In fact, if you ask a retail forex trader about options, he/she would probably think of binary rather than vanilla options. There are major differences between the two with the similarity being mainly in the word options being used for both types.

A binary options trade gives the buyer the right to buy an asset (e.g. EURUSD) at a fixed price within a specified time period that can be as short as 30 seconds or as long as 24 hours or more. There are only two possible results in a binary options trade: either it ends in the money (winning) or out of the money (losing). Some refer to it as all or nothing trades.

Differences between Binary Options and Vanilla Options

1)    Vanilla options have fixed expiration dates, such as weekly, monthly and quarterly although they can be quoted for any period. Binary options also expire at different time frames, such as by the hour, day or longer.

2)    Vanilla options prices are influenced by price changes in the underlying asset, volatility and time decay.  In binary options, the payout is fixed at the time of purchasing the option. An example is a payout of 71% when the trade expires in the money and a 15% payout when it expires out of the money.

3)    A vanilla option can be exercised by the seller or liquidated by the buyer at any time before expiration. Binary options cannot be exercised until expiration.

How these differences impact trading

1)    Binary Options offer flexibility by providing multiple expirations to trade as opposed to vanilla options that has a limited number of fixed expiration dates.

2)    In binary options, the buyer knows the payout when the trade is put on where there are only two outcomes. By contrast, in vanilla options, the price of the option will fluctuate and at expiration, will be determined by the difference between the expiration and strike prices.

3)    The buyer of a binary options contract needs to hold it until expiration while the buyer of a vanilla option can liquidate it at the current market price any time before it expires.

These differences have several consequences:

1 The short term multiple expiry times means investors can make an instant profit on their binary options and are more flexible in their option investments

2 In vanilla options, an investor pays per contract (i.e. point). Subsequently the investor will profit or lose an amount depending on the number of points difference between the expiry level and the strike price. Unlike in binary options where the two outcomes are set from the start

3 An investor in a binary option must hold onto his option until the expiry date. He must therefore take more care when purchasing his options as he cannot sell them once they are purchased

Retail forex traders seem to favor trading binary options because they are easy to trade, can get quick results and have flexibility in multiple expirations. Investors need to plan their binary options trades since once put on; it is a wait until expiration for the result. 

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