A binary option, also known as a digital option or an all-or-nothing, is a trading instrument with a fixed return that is determined at the outset of the trade. A trader will receive a predetermined payout if his binary option expires in-the-money, and he will lose a predetermined amount of his initial investment if the option expires out-of-the-money.

The degree to which the option is in-the-money or out-of-the-money does not matter as it does with a traditional option. All markets—currencies, stocks, commodities, and market indices—can be underlying assets for binary options.

Unlike traditional options, binary options do not have set prices–the trader decides the amount of money he wants to risk and invests that amount when he buys the option. The time of expiration for binary options are set at different time intervals throughout the day, such that at any time a trader can purchase an option that will expire in 1 month, 1 day, 1 hour or even 5 minutes. The shorter duration of the contracts makes binary options more suitable for short-term, intraday trading than their traditional counterparts.

An example of a typical binary option trading:

One morning at 10am a trader reads the morning news and sees that the price of oil, trading at 79 USD per barrel, will rise to 80 USD per barrel by 2pm. She logs into her binary options account and examines the payout percentage for the call option on oil with a 2pm expiration and a strike of 80 USD. She finds that the payout will be 170% of her investment if the option expires in-the-money, and she will lose 90% of her investment if the option expires out-of-the-money.

Confident in her analysis of oil, the trader decides to invest 500 USD in the call option. When expiration occurs at 2pm, oil is trading at 80.25 USD, so the option expires in-the-money. The trader receives a return of 170%, or 850 USD, on her 500 USD investment.

You can trade binary options through a number of different binary option brokers.