What is the Difference between a Binary Option and a Vanilla Option?
The evolution of financial trading leads to the appearance of new progressive trading instruments on the market. This is what happened with binary options, which became a kind of continuation of the development of the simple vanilla option, which is well known among investors since the late 90s. Binary options traders, for a start, do not always understand the differences between these trading tools and cannot determine their advantages. Therefore, we want to analyze how different types of options work and identify their advantages and disadvantages for the private trader.
So, let's start with the classics - vanilla options. This type of contract gives the right to purchase a certain asset at a fixed value in a certain time interval. The profit in this case will depend on the amount of change in the value of the underlying asset. This type of option contracts are widely used by large companies and investment banks as a means of diversifying risks and an instrument for obtaining additional profits. It is worth mentioning that trading a vanilla option will require an investor to raise a large amount of working capital, since the purchase of the contract takes into account the market value of the underlying asset, which makes a vanilla option unaffordable for the average private investor.
In this regard, binary option is more attractive. Today, anyone can engage in binary trading with the help of brokers' online platforms. At the same time, minimal funds are required for trading, for example, at Binomo broker You can start financial trading with binary options with an initial investment of 10 USD. So what's the difference between a vanilla option and a binary option? Without a doubt, a binary option is a kind of derivative from a vanilla stock contract. However, there are significant differences and advantages. First of all, in the profit system. In case of a vanilla option the profit depends on the level of the asset price change, in case of a binary option there is no such dependence, all the trader gets is a fixed profit by placing a bet on forecast of the market movement. Moreover, the profit level doesn't depend on the rate of the underlying asset quotes fluctuations but rather on the underlying asset itself, or to be more precise, on the rate of option profitability offered by the broker. Today, this figure ranges from 65 to 87%:
Also a significant difference is the absence in binary trading of direct purchase of the asset. Here as a condition of receiving profit only the direction of forecast of movement of quotations of the underlying asset and it does not matter how much an asset is at a certain moment of market fluctuation, a contract on binary option can cost from 1 USD. Such trading conditions are offered by one of the leading brokers on the market - the company Binomo. This important trading condition makes a binary option the most attractive for financial trading.
So, binary option - is a bet on the change in the value of the asset in a certain time interval, which, by the way, is determined directly by the trader himself:
In the vanilla option (Wikipedia) everything is much more complicated - the market participant cannot determine in advance the level of profitability of the contract, the volume of expected losses, as well as has a lot of indicators that complicate the trading process. It is because of the complex trading algorithm that the vanilla option has not become as popular among private traders as the binary option.
Binary option has a more simple principle of work: having made a bet on a certain direction of market movement, setting the term of the contract, the trader receives profit upon confirmation of the forecast, knowing in advance the expiry time of the contract, the amount of income and the level of possible losses. Formalization of binary option indicators allows to accurately calculate the risk indicators and correctly manage own trading capital.
It's worth summarizing what the main advantages of binary options are:
- Simplicity of the trading algorithm
- High level of accessibility
- Minimum parameters of trading conditions
- High efficiency and effectiveness of the tool
Thus, as a result of the evolution of the vanilla option, we got a highly effective tool that is fully adapted to work in the financial market of the private trader.