Details about Binary Options Trading Explained with Examples
This series of articles covers the very popular options called Binary Options which are heavily traded in the derivatives market.

As we will see in the following details, the Binary Options have all-or-nothing kind of payoff - i.e. either the Binary Option Buyer gets (all) fixed amount or he gets nothing.

Explanation of Binary Options:
The word "Binary" means two - and that's where the Binary Options got the name. Binary Options have only two outcomes - either all of the pre-decided amount OR nothing (zero).
Traditional options have a linear payoff structure i.e. the amount of money received/lost will keep on increasing (or decreasing) as the underlying price keeps moving. Hence the payoff in traditional call and put options is not fixed - it keeps varying as per the movement of the underlying.

Unlike the traditional options, the binary options have ONLY 2 possibilities - entire amount or no amount. Imagine the case of a switch - it can be either ON or it can be OFF. There is no intermediate stage for a switch other than ON or OFF. Similarly, the Binary Options have only 2 possibilities - either everything in payoff, or nothing in payoff. See the following section for more clarity.

How Binary Options work?
Binary Options have their own set of rules which may be a bit different from the traditional call and put options.
Binary Options work on a pre-defined limit prices (equivalent to strike prices in call and put options). Binary Options work exactly the same way a simple bet between two people work. To understand more clearly how Binary Options work, lets say you and your friend decide to bet on the outcome of a soccer match between 2 teams - team A and team B. You say team A will win and your friend believes team B will win and you both get into a $100 bet for your respective teams. Assume there is no possibility of a draw - only 2 possibilities are there - either team A wins or team B wins.
So what happens in this bet? How is this bet structured?
Basically, it boils down to only 2 outcomes - either you win the bet or your friend wins the bet. The winner will get $100, the looser will pay that $100 to the winner.
There is a condition attached to winning the bet - your respective team should win.
There is also a pre-determined fixed amount - $100

Similarly, the Binary Options work. There is a condition attached to the Binary Options, but it is in a number form (similar to strike price of a call or put option).
If the underlying stock price goes above that number value (or price value), then the buyer will get the entire pre-decided amount from the seller of the Binary Option.
If the underlying stock price remains lower than that number value (or price value), then the buyer gets nothing. The seller keeps the Binary Option Premium earlier paid to him by the buyer.
Still not clear, see the example in next section.

Let's continue to understanding the Binary Options better through Payoff Functions: Binary Options Trading Example Explained