A Digital Option is a type of option in which the pay-out can take only two possible outcomes: either you are paid the return in a predefined fixed amount upon the occurrence of the event on or before the expiry date, or you lose the amount invested in the option. Simply stated, a Digital Option is generally held until expiry in an “all or nothing” pay-out structure and based on a simple “yes” or “no” proposition: Will a currency pair touch a set price on or before a certain date? This is different from a traditional FX option which grants the right, but not the obligation to buy or sell a currency pair at a set price on or before a certain date.
The maximum loss is known when you trade a Digital Option, and depending on whether it is a buy or sell position, the premium or the notional/pay-out (whichever represents the maximum loss) is reserved from your account in full when the Digital Option is dealt, i.e., the product cannot be traded on margin.
Whether a Digital Option is regulated will depend on its underlying asset. Where the underlying asset of the binary option is traded OTC such as FX spot, it is important to note that the OTC markets are largely unregulated due its decentralised structure where deals take place directly between two counterparties and liquidity is fragmented across different venues. Therefore, the level of regulatory oversight and transparency in an OTC market is very low compared to that of a formal exchange which is required to maintain fair, orderly and transparent markets.
Tradeable tenures for Digital Options are available from 1 minute to 1 hour. Digital Options with shorter tenures are riskier as investors may be exposed to short term volatility and further, it is challenging to consistently predict the performance of an underlying asset within a short period of time.
You should not engage in Digital Options trading unless you fully understand the basic aspects of such trading as well as its associated risks. By trading in unregulated financial products, investors will not have the protection afforded under the regulatory framework which are only available in the context of regulated offerings.
For example, if you buy a Digital Option, then the maximum amount you can lose is the premium paid up-front (you stand to receive the notional/pay-out amount if the option “touches”). You must be able to pay this premium upfront, which is deducted from your account at the point of trade, and the market value of the Digital Option position cannot be used as leverage to support any other existing or new open positions from a margin perspective.
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