Written by: Sophie May
Binary options and vanilla options are both types of financial instruments. Traders choose to buy or sell the options, depending on whether they believe that the asset will increase or decrease in value. These options exist for a whole range of underlying assets. Assets can be foreign currencies, stocks, bonds, indices, futures or commodities.
Decades ago, all exchange traded options were vanilla options. Now these options are often referred to as “plain” vanilla options, in contrast to all their variants, such as binary options, which have newly sprung up. Vanilla options have no special features or terms. They are generally traded on an exchange such as the CBOE. In contrast, binary options are most frequently traded online through trading platforms accessible to the public.
A binary option has two possible payout amounts. Either the option expires in-the-money and the investor receives a profit of around 70% to 80%, or the option expires out-of-the-money and the investor receives a small amount or nothing of his investment. If a trader expects the value of oil to decrease in the next hour, it does not matter whether the value of oil goes down by 1 pip or 100 pips from the strike price, the price when the trade is opened. So long as the value does decrease, by whatever amount, the trade is deemed successful and the payout is the same.
When trading vanilla options, the payout is not defined in advance. Instead, exact price points matter. A vanilla option gives the holder the right, but without any obligation, to buy or sell an asset at a predetermined price, the strike price, within a given time span. The holder must pay a premium for this right. If the trade is never exercised, the investor has simply lost the premium. If the trade is exercised, the end payout is dependent on the price of the underlying asset relative to its strike price.