Binary Stock Options

Binary stock options are a type of speculator-geared option contract which comprises a definitive cash award, or payoff, if the market price of the underlying stock reaches or exceeds a specific level upon the option's expiration date. If the stock price does not reach this level within the appropriate time frame, the contract expires with no cash award at all.

Stock Options

• A stock option contract gives a holder the non-compulsory right, or option, to buy or sell a number of shares of a specific stock (underlying stock) at a definite price per share (strike price) on or before a predetermined date (expiration date). The strike price remains effective regardless of changes in the market price of the underlying stock. Stock options are a popular tool among speculators, because the value of the contract itself fluctuates according to movements in the stock's market price prior to the expiration date.

Put Options

• Investors who already hold and intend to sell shares of a particular stock engage in a "put" option contract if they believe strongly that the market value of that stock will reach or decline below a specific price level before a future date. In the secondary market for options, a put option rises in value as the market price of the underlying stock continues to drop below the strike price in advance of the expiration date of the option. A put option has no value if the market price of the underlying stock is higher than the strike price.

Call Options

• Call options are purchased by investors who intend to purchase shares of a given stock, believing strongly that the stock's market price will reach or exceed a specific price level prior to a future date. In the secondary market, the value of a call option rises in response to the amount by which the underlying stock's market price exceeds the strike price prior to the option's expiration date. A call option has no value if the market price of the underlying stock is lower than the strike price.

"In-the-Money" and "Out-of-the-Money"

• Options whose outcomes are successful, or have a secondary market value greater than zero prior to expiration, are described as "in-the-money". A put option is in-the-money as long as the market value of the underlying asset remains lower than the strike price. A call option is in-the-money as long as the market value of the underlying asset remains higher than the strike price. In instances in which these respective conditions are not met, an option is described as being "out-of-the-money", or worthless.

Binary Stock Options

• Binary stock options, also called cash-or-nothing options, are issued as both calls and puts and are structured in a similar manner to those described above. Binary stock options differ from traditional options, because they offer only two possible outcomes at the time of expiration. A predetermined cash payment based on the strike price is awarded to the holder, regardless of the market difference, if an option is in-the-money at the time of expiration. If an option is out-of-the-money upon expiration, the holder receives nothing at all.

Example

• To illustrate, suppose an investor believes that stock XYZ will appreciate in value and have a market price of $100.00 per share on December 31st, 2010. This investor purchases a binary stock call option on 10 shares of XYZ stock. With a strike price of $100.00 per share and an expiration date of December 31st, 2010, the option comprises a cash award of $1,000.00 ($100.00 x 10 XYZ shares). As long as the market price of stock XYZ is greater than or equal to $100.00 (in-the-money) on December 31st, 2010, the investor will receive no more and no less than $1,000.00. Conversely, if the market value of stock XYZ is less than $100.00 (out-of-the-money) on this date, the investor will receive no cash payment at all.