Binary Options Vs CFDs

Binary options vs CFD (contract for difference) trading is a common debate regarding two very popular derivative instruments. This article will provide an introduction to binary options vs CFD trading with a discussion of each instrument type and a detailed comparison of the two.

What Are Binary Options?

When considering the binary options vs CFD trading debate, it is important to understand that they both allow traders to speculate, or bet, upon the future price of a trade. As the name of the former suggests, however, binary options are either ‘yes’ or ‘no’ positions and there is a pre-determined profit or loss on each trade.

Essentially, binary options are a prediction of whether the price of an asset will exceed or drop below a pre-determined position, often the value at the opening point, known as the strike price. If correct (known as ‘in the money’), a trader will receive a pre-agreed sum – sometimes a percentage of the original position – and if incorrect (known as ‘out of the money’) the trader will lose the entirety of the original position.

For example, if an investor believes that the share price of Deliveroo will rise above $50 by 12 July at closing, they may purchase a ‘yes’ binary option for $100 at a 77% pay-out. If the trader is correct and the share price is $54 at the closing date, the trader will receive $177 (a profit of $77). This figure would remain the same, regardless of how far above the strike price Deliveroo’s share price is. However, were the share price to drop to $49, the trader would lose the full $100 trade option.

The above example is known as an up/down or high/low binary option, predicting whether an asset’s price will exceed or fall below an agreed price; however, there are other types available:

In/Out:

• traders predict whether an asset’s price will fall within or outside a pre-determined price range or boundary.

Touch/No Touch:

• traders predict whether the asset price will touch a certain figure at any point within the agreed trade window.

What Are CFDs?

A CFD, or ‘Contract for Difference’, is a financial contract between a trader and a broker that exchanges the spread between an asset’s opening position and its closing position at a specified time.

Essentially, it allows traders to bet on an asset’s price movement, making a profit or loss depending on the price movement of the asset. Notably, CFD profits are dependent on both the direction and value of price movements.

Traders never actually own the underlying asset – for example, an ETF, currency pair, or commodity. This provides added market exposure, as you wouldn’t need to take delivery of a thousand barrels of oil if you were to purchase oil CFDs. Moreover, CFDs allow traders to ‘go long’, purchasing a position that anticipates a price increase, or ‘go short’, selling a position in anticipation of a price decrease.

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Similarities Between Binary Options Vs CFD Trading

There is a range of similarities and differences when considering the binary options vs CFDs debate. The success or failure of both trade types relies on correctly predicting whether the asset’s value will appreciate or depreciate.

Both instruments are also derivatives, which means that investors do not take ownership of the underlying asset, they are simply speculating upon the direction of price movement. This makes them both relatively cheap and removes entry barriers like large capital requirements for expensive share prices.

Differences Between Binary Options Vs CFD Trading

The main difference between the two instruments is that the profits or losses that CFDs produce depend on how far the value of the underlying asset moves. Binary options, on the other hand, produce a predetermined profit or loss that is determined by the direction of the price movement.

Binary options are generally higher risk, higher reward derivative products than CFDs, facilitating big potential profits in markets you are confident about. While earnings from CFDs tend to be lower (compared to the money staked), the opportunity for stop losses and other risk management strategies produces a more secure foundation to trade from.

Binary options also provide the opportunity to make profits by correctly predicting that the asset’s value will neither appreciate nor depreciate with in/out options. There is no CFD equivalent.

Finally, the cost structures of binary options vs CFDs are very different. The former works much like a bet, with the entire investment lost if the option is out of the money. CFDs, on the other hand, involve a commission or spread-based pricing structure that eats away at a small percentage of the trade size.

Final Word On Binary Options Vs CFD Trading

As with all forms of financial trading, the question of binary options vs CFD comes down to a trader’s appetite for risk and reward. Binary options produce big profit margins and give clear visibility over potential gains or losses with their binary ‘yes’ or ‘no’ outcomes but it is an all or nothing approach. CFD trading is more secure and risks less of your account capital, though profits are not usually so impressive.

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