There are all sorts of things you can invest in these days, ranging from stocks to bonds to more weird stuff like options or triple leverage ETFs. That last one is when you want to invest to THE EXTREME.
Options are really interesting, at least from a high risk high reward perspective. Here’s how they work, in a nutshell. You pay a premium in exchange for a contract that gives you the right to buy a certain security on a certain date at a certain price.
Keep in mind this doesn’t have to be a stock. You can buy options on just about anything. Commodities and currencies are fair game. In fact, the option market for these securities can be even bigger than with stocks.
One of two things happens. Either the thing you were looking to buy rises above the option’s strike price (which is a good result, making you anywhere from slightly to much richer) or it fails to rise(which is a bad result, and you lose the entire premium).
Because these options have only two real outcomes, they’re commonly referred to as binary options.
The neat thing about the option market is it’s easy to take bullish or bearish positions. Call options are used to bet with the market and put options are used to bet against the market. You can also go short by selling a call or go long by selling a put, which enables you to collect the option premium in exchange for taking on the underlying obligation.
Okay, all that sounds pretty complicated, right? I’ve just scratched the surface of options. There are books written on the topic that are inches thick, and I’m sure not about to go read them. I can barely get through Dr. Seuss.
A number of companies have made options easier. They offer investors simple options called high-low options. All an investor needs to do is decide whether an asset will be above or below a certain price. Think of them as yes/no options.
Do you think gold will be above US$1400 per ounce a month from now?
Do you think oil will be above US$50 per barrel six months from now?
Do you think the S&P 500 will be above 2,300 in a year?
And so on.
That’s how to trade with binary options. It’s pretty simple. Now how does that compare to forex trading?
One of the biggest differences is through leverage. Since currencies don’t tend to move much (the big Brexit-caused move in the British Pound notwithstanding), the exchanges let folks trade forex with a lot of leverage. It’s common for regular folks like you and I to put down 5 cents of our own capital to control a dollar worth of currency.
Most days this is fine, since a move of a half cent is considered to be a big day. But every now and again it really comes back to bite someone–assuming they’re on the wrong side of the trade, that is. This leverage is both a strength and a weakness of the forex market.
Remember, binary options let you trade foreign currencies just like trading forex does. The nice thing about using a binary option to speculate in currencies is your loss is limited to just the amount invested.
Let’s look at an example. Say you wanted to bet on the British Pound before Brexit. Like the rest of the world, you thought remain would win, so you went long Sterling using all the leverage you could get. You took $10,000 of your own money and used it to borrow $190,000 of Sterling.
We all know what happened next. Pounds plunged from $1.4787 (all figures in USD) to $1.3223 in a matter of hours. It trades even lower as I write this, falling all the way down to $1.312.
A loss of more than 10% is hard enough to stomach when it’s all your own money. But when you’ve only put down $10,000 on an investment worth $200,000, it represents a loss of 200% of the capital invested. Not only have you lost all your money, but you also owe the forex dealer $10,000. Good luck with that.
Here’s where a binary option is a better choice. If you would have bet $10,000 on the Pound trading at say anywhere above $1.45 by the end of July, you still wouldn’t be in a good place right now. But at least you’d only be out your own cash.
And remember, binary options can have nice payouts depending on which ones you choose. So if you would have used them to short the Pound going into the vote, you’d be pretty much swimming in dollars right now.