Digital Options

Digital options trading is a simple way for traders to speculate on the future price of an asset with an outcome that is either correct or incorrect, similar to binary options. This guide will cover the definition of digital options, the different types and how to start trading this popular financial product.

Digital Options Brokers

Digital Options Explained

Digital options allow traders to predict whether the future price of an asset will be above or below a specified strike price, via a statement like ‘the price of Stock A will be less than $500 at time expiry’.

As the outcome can only be true or false, the trader will receive either a set profit or loss, which will be decided in advance.

As a derivative, traders can use these options to predict future prices without ever owning the underlying asset.

This makes them popular with beginners new to the financial markets.

How Digital Options Work

When trading digital options, the trader manually sets a price that they believe an asset will hit within a defined period of time, which could be higher or lower than the current trading price.

The broker then determines how likely it is that the asset will reach the strike price at the expiry time point, by pricing the digital option between 0 (least likely) and 100 (most likely).

The formula that brokers use to set digital option pricing will take into account asset volatility and length of time until expiry. This has led to another name: a digital 100.

The trader’s profit or loss is calculated using the difference between the price and the speculated closing price, multiplied by the price staked per point. For example:

• The quoted price is $60 and the trader stakes $1 per point movement
• If the price hits the $60 price at the time expiry, the profit would be (100 – 60) x $1 = $40
• If the price does not hit $60 at the time expiry, the trader would lose (60 – 0) x $1 = $60

As potential losses are always bigger than potential gains when trading digital options, the trader must have more correct options than incorrect options to make a profit overall.

Types Of Digital Options

• Ladder – these options provide traders with the opportunity to lock in profit if the price reaches intermediary points to the strike price, known as ‘rungs’. This reduces the risk associated with options trading and is especially useful if you think the price will move but are unsure of the direction.
• Up/Down – a trader determines whether the asset price will be above or below a certain level (the strike price) at the time of expiry.
• One-Touch – one-touch options allow the trader to receive a payout if the asset price touches the strike price at any point before the expiry time.
• Target – two strike prices are set for target options and the trader will receive a payoff if the price closes within the range. These are also referred to as dual digital options.
• Hi/Lo – the trader predicts the range for the market’s daily high or low; a good choice when confident about the volatility of an asset.
• Tunnel – these are similar to target options in that an upper or lower strike price is set, though the trader will only receive a payout if the asset does not touch either strike price at any point. Tunnel digital options are also referred to as double-no-touch options and are a good choice if you think the market is likely to stay flat.

Digital Options vs Binary Options

When comparing binary options vs digital options, there are a few key distinctions:

• Timeframes: The available contracted timeframes differ slightly on binary options vs digital options. Digital options tend to be offered with closer expiry times, which could be suited to scalpers. However, specific times may depend on the broker, platform and asset.
• Risk Levels: Trading digital options can result in a loss beyond your initial investment. The further the price moves away from the initial strike price, the greater the loss. On the other hand, traders only lose their initial stake with binary options.
• Profit Potential: Similar to the amplified risks, trading digital options can increase profit potential the further away the price moves from the strike price. With binary options, traders can only gain a fixed return.
• Control Over Strike Price: Digital options allow traders to manually set a strike price, meaning they can exercise more control over their trade. The nature of binary options only requires you to say ‘yes’ or ‘no’ to whether the asset’s value will rise.

There are a handful of similarities to note between binary options vs digital options:

• Buy Or Sell: Users buy if they believe the market moves above the strike price or sell if they predict the asset will move below the strike price.
• Two Outcomes: Both binary options vs digital options only have two outcomes, correct or incorrect.
• Expiry Date: Binary options vs digital options operate with a predetermined expiry date, at which point the position is automatically closed. However, digital options provide the opportunity to close a position before the expiry.
• Derivatives: Traders do not own the underlying asset they trade. Depending on the broker, trading can be a lot cheaper and flexible because of this. Additionally, you may be exempt from certain taxes, depending on your region.

Binary options are a prediction of simply whether a price will have increased or decreased from the current position at the point of expiry.

This means the current price is the strike price, unlike with digital options where the trader speculates on both the direction and distance of the strike price.

With both types of options, the more attainable the prediction versus the strike price, the lower the potential profit.

Pros

Trading digital options offers a number of advantages:

• Profits can be large for a correct prediction, even within short timescales
• Hedging can be used to offset some of the risk
• The trader knows upfront what their potential profit or loss will be

Cons

As with all types of trading, there remain some drawbacks:

• Digital options trading is banned for retail traders in lots of countries, meaning regulated brokers can be difficult to find
• When you lose a trade, you lose your entire outlay

Regulation

Digital options are often compared to gambling, which means they have strict restrictions in some countries.

Unfortunately, the FCA and ASIC ban binary options for retail traders in the UK and Australia.

Digital options trading is only permitted in the US when traded on one of three regulated exchanges: the Cantor Exchange, Chicago Mercantile Exchange or North American Derivatives Exchange (Nadex).

That being said, ESMA removed its binary options trading ban for retail traders in the EU on 1st July 2019.

The CySEC leads the way with digital options trading, implementing strong regulations for binary options brokers.

How To Start Trading Digital Options

Now that we’ve covered how they work, let’s look at how to get started:

1. Select A Broker – a broker provides digital options traders with access to the markets. As well as ensuring they’re regulated with a reputable authority, you should check if they offer the tools you require, such as a signals service, mobile app or demo account to let you practice your trades before using real funds. There may also be account rules in place, such as minimum deposit requirements – IQ Option is a good example of a broker that offers a low minimum deposit of just $10.
2. Select The Asset – digital options can be traded with a variety of assets, including gold and FX. The liquidity and volatility of the asset will influence potential payouts.
3. Set The Parameters – these will be based on your trading strategy and analysis. An example of these strategies is hedging digital options with a call spread, by buying a call at one strike and selling a call at a higher strike. Other analysis includes calculating the delta, a measure of trading risk that looks at the ratio between the underlying asset price and the change in the price of the option.
4. Sit Tight – once you’ve entered your position, sit tight and wait for your asset to hit the strike price or expiry. With that said, at some digital options brokers, it is possible to exit the position early if the binary outcome is looking unlikely to be in your favour, which can limit losses.

Final Word On Digital Options

Digital options are a straightforward way for traders to speculate on the price of a range of assets with either a true or false outcome.

Their simplicity lends themselves well to new traders, although the risk per trade can be high, with experienced digital options traders often using hedging to reduce potential losses.

Use our list of top digital options trading brokers to get started.

FAQs