Digital Options Explanation

Digital Options Explanation

Digital options are options which pay a fixed amount of dollar amount or nothing at the time of the expiration. Since the payoff in these options is a fixed amount they are known as fixed return options or FROs. These are also most commonly known as binary options. Digital options came into existence due to the efforts from the investors and traders to reap in more simplified ways of trading options in the financial markets.

In the digital options explanation, the value of the payout is set at the time of issue of the contract. This payout is independent of the magnitude at which the price of the underlying asset moves. This means, that whether you have invested $1 or $5 in digital options, your gains will be the same.

One important thing to note about these options is they are very simple to trade and hence more and more are trying to invest in digital options. The only thing a trader investing in digital options needs to look at is whether the underlying security finishes above or below the level than what it was at the time of purchasing. These options are different from stocks as unlike stocks the trader does not own the share but just bets on the performance of the price of the share.

A wide range of underlying securities are covered under the digital options. These underlying securities mostly include the stocks, currencies, indices as well as commodities. Digital options are mostly European style options. This means that these options are traded only at the time of expiration. This is in complete contrast of American style options which can be traded at any time.

The payoff in digital options is often predefined. For majority of options, the payoff is highly unknown. The trader is able to know about the payoff only at the time of exercise of the option wherein the payoff for the call option is the asset price at the time of exercise minus the strike price of the options.

Benefits of trading in digital options:

The benefits of trading in digital options are plenty. Some of the benefits of trading in digital options are mentioned below:

  • They are simpler and easier: The investor only needs to have a sense of direction and need to keep an eye on whether the exchange rate is going to increase or decrease with time.
  • They involve controlled risk: As the amount of rewards is already known since their issue, the risk involved in the digital options is within the control of the trader.
  • Offers protection: The digital options are the safest option to invest especially if the trader has an open position other financial instruments. By investing in digital options, the trader can reduce losses in other instruments.
  • Easily accessible: The digital options are issued round the clock. Owing to this, the traders can trade even on multiple time frames.

Considering that more and more investors are investing in digital options it is advisable that you invest in these options under the guidance of your financial advisor.

Digital Options Explanation

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