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Options are one of the basic types of derivatives: they allow you to speculate on the price of a certain underlying asset. Options can be very profitable, but they are considered extremely risky as well, and you should definitely understand how they work before trying to trade them. The most important thing a novice trader must understand is the difference between binary options and classic ones, and we’re going to explain that difference in this Traders Union article.
Vanilla options (also called classic) are your common derivatives: they give you the right to buy or sell an asset at a specific price. Each option has an expiration date, and you can’t use an option after that date. These derivatives are frequently used as a protection against the price going up or down: such a security means you will definitely have the opportunity to sell or buy a certain asset. For example, you know that your company will need a large amount of a specific foreign currency quite soon. An option is a nice method of making sure you won’t have to pay more than you’re expecting.
However, binary options are very different from these derivatives: think of them as a more simple and straightforward security that allows you only to win or lose without any other outcome. Let’s see how a binary option works and how to compare options vs. binary options.
Binary options don’t give you the right to buy or sell any assets, so they are useless for hedging. They are intended only for profits: you make a prediction about whether the price of a security will fall below or rise above a certain level. If you are right, you get your payout. If you are wrong, you lose your bet, and there are no intermediate options. That’s why these securities are called binary. Such options are considered extremely risky, and binary trading is prohibited in many countries. However, there are still certain brokers that allow you to trade them without any limitations.
How are they different?
The main difference between these types of options is that binary options have fixed yields: once they are bought, there’s nothing you can do, only wait for the outcome. Vanilla options have varying yields, and you can actually decide to exercise the rights given by them up until the expiration date. But both of them can be based on different assets.