There seems to be a lot of chatter and momentum in the options space about binary options. A binary option is different in that it has two outcomes, max gain or max loss… hence the name, "binary option". So unlike a regular option, these options do not have infinite gains nor variable gains based on how much higher the underlying is above the strike price at expiration. The gain can either be an asset or cash, and these options are bought or sold for a premium.
Basically, these options are like a sports bet. Let’s say you put $10 down on a 50/50 chance for a team to win. If you are right, you get paid back $9, if you lose, you lose $10. Because of this, it is foolish to buy binary options if you are paying a premium since the payout is a 50/50 chance. In fact, in many countries, binary options are considered a form of gambling and are illegal. Many binary option brokerages have turned out to be scams, so when it comes to binary option trading, do not even bother.
However, one thing that binary options do offer is a great way to evaluate pricing models and option pricing. From an option pricing point of view, a binary option kind of acts like a vertical at the same strike, making for much easier calculation of return to risk. It also is shown to be a great tool to measure the efficiency of the return of a vertical, since the middle ground of a vertical is the non-binary part of the calculation and tends to get in the way of the OCD option trader’s return to risk calculation. Therefore, a 1 wide vertical in most underlying vehicles can synthetically represent a binary vertical. I highly recommend that, since the return-to-risk is higher in that strategy than any other vertical spread as shown by binary options.
In short, binary options are the academic option student’s delight, but from a practical standpoint, they are a scam.