Digital Options Demystified

Digital options are the easiest of the derivative contracts to manage and explain. First, a derived contract is based on other contracts but is separate from them. Options are defined as a trade that has a fixed payout after the underlying stock has passed the bargaining price. Digital ones are also described as binary or all-or-nothing options.

The payout of a digital option is determined at the beginning of the contract. It does not depend on how the prices moves or whether prices move high or just a bit. The amount you receive with an option is the same whether or not the stock moves in short spurts or pays out huge sums. You set the price you will receive at the beginning.

digital-options-demystified

Think of digital options as friendly bets. “I will bet you that the sun comes out tomorrow. If it comes, I will give you my new backpack. Conversely if the sun does not come out, you receive nothing.”

This is a bit simplistic, but it basically the working of an option.

Digital Option Payoff

Digital options are very popular among online traders. They can move assets, place predictions and learn the results almost instantly. Traders receive a fixed payoff if the digital options expire “in the money.” There is little speculation in digital option payoffs; you know what you will get at the onset. It doesn’t matter how much prices go up or down, the option just needs to expire “in the money” or higher than the strike price.

Being in the money means that the trader predicted a rise in the stock assets, binary, commodity or market shares. It is not important what the amount of the change is, it only matters that it changed and in an upward movement. If your prediction is correct, you can make a substantial amount of money.

Take the example of Apple’s stock. You call in an option on the stock prices and predict Apple’s stock will be greater on expiration than its current purchasing or strike price. If the price is higher when the option expires, you have just made a profit. You get the increase that you predicted.

Other terms to understand in regards to binary options and digital options include “at the money” and “out of the money.” These are exactly what they say. At the money means the price of the underlying asset stayed the same on expiration. There was no movement up or down and no profit made. A percentage of the trading priced can be returned to the trader.

“Out of the money” indicts that the prediction of the asset was all wrong. Suppose you predict that a certain stock asset will go down. That is your “bet” or prediction. Upon expiry the asset actually went up. You predicted wrong. You do not make the big payout, but you will get a portion or percentage of your trading amount returned to your account.

You can learn to predict price movement if you research. Open a trading account that gives you the opportunity to demo trades or practice predictions with “play money.”

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