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Digital Options

Discover the World of Digital Options

Digital options are those in which the payout is fixed after the underlying asset exceeds the predetermined strike price. Digital options are sometimes called "binary" or "all-or-nothing". The amount of the payout is determined when the contract is purchased, and so and doesn't depend on the amount or percentage by which the price of the underlying asset moves; all that matters is which direction it moves in and if it moves enough in that direction (to get above or below the strike price, depending on whether you bought a call or a put). So you might be in the money by $1 or by $100; it doesn't matter, as long as you speculated correctly about whether the asset price would be above or below the strike price at the contract's expiration your payout will be the same. If you were wrong, you get nothing and you've lost your premium investment.

In the digital options system, the payoff on the contract is preset as either cash (a Cash-or-Nothing option) or a unit of the underlying asset (an Asset-or-Nothing option). So for the cash digital options you'll be attempting to get X amount of money. For the asset digital options you'll be attempting to get ownership of X shares of the underlying asset.

Digital options are "exotic" options, not "plain vanilla" options. Exotic options are different from the common American or European options because the nature of the underlying asset or the calculation of when or in what way you would get a particular payoff is different. Exotic options allow their investors to get involved in what would otherwise be too-sophisticated investment vehicles for most people to have time to properly understand. The digital options system, in fact, is attractive because of its great simplicity. Digital options often get used by more experienced investors for dynamic hedging, but they are excellent vehicles for the new and inexperienced options investor due to their simplicity.

So, let's imagine how the digital options contracts work. Imagine that you purchase a digital call option for a premium of $10 with a stated payout of $30 on PDQ stock at a strike price of $60. We come to the expiry date, and PDQ is trading at $60.75 Since the price of PDQ is indeed above the $60 strike price, even though only by less than $1, you get paid $30 (on top of your premium coming back). On the other hand, imagine if PDQ were trading at $59.75; you would get nothing and your $10 would be lost. Also realize that if PDQ were trading at $180 on the expiry date, you still get a profit payment of $30 and no more than that.

The vast majority of digital options' underlying assets are not equities, however; they are typically the results of certain events such as the value of the Gross Domestic Product or the level of the Consumer Price Index on such and such a date. So although digital options can be liquidated prior to expiry, early exercise of your option is typically impossible because the nature of the underlying asset is such that the date of expiry must be reached before it can be determined if your speculation was right or wrong.

Once you have a grasp of the digital options system you can see how simple it is to invest in digital options contracts, even if you are totally new to options or exotic options. There is no need for a ton of research, no need to understand Fibonacci, etc. You just learn a little about the underlying asset of a particular contract and get a feel for understanding whether or not it will probably be higher or lower than the strike price an hour later, a day later, a week later, three weeks later, or whatever the timeframe of the contract is. Once again, remember that you don't have to be right by very much. The magnitude by which the underlying asset price is above or below the strike price means nothing; all that matters for you to make money is that you were at least "barely" right.

In digital options investing, the "call" option is when you bet that the asset price will be above the strike price at expiry. The "put" option is when you bet that the asset's price will be below the strike price at expiry. So, if you buy a digital options call, you get your payment if the price ends up higher than the strike price. If you buy a digital options put, you get your payment if it ends up lower than the strike price.

So, learning the digital options system is great for just about everyone. New investors can learn simple options investing so that they minimize their risks. The more experienced and savvy investors can use digital options for dynamic hedging purposes. Just remember that if you've never been involved with the digital options system before that you still want to paper trade first before you risk real money. You should always do this when first learning any new investment type.