Binary Option vs. Vanilla Option

A binary option which is also known as “digital options” for the fact that they offer only two outcomes of a trade are quite different from the standard vanilla option. Trading in binary option has the payoffs to be a fixed predetermined amount which is paid on the correct prediction of the price movement at the time of expiry.

On the other hand a vanilla option is the standard form of trading where there is an expiration date and a strike price and has the most standard features.

Differences between binary and vanilla option

1. Payout profile: the major difference between the two is the payout profile. The binary option payout is a fixed amount that is predetermined at the time of signing the trade contract and if the trade is “in the money” this predetermined amount is paid to the trader. On the other hand, the vanilla option payout is not fixed and if on expiry the trade is “in the money”, the payout depends on the difference by which the traded instrument clears the strike price.

2. Trading patterns: in the U.S. a binary options is also traded on inflation figures such as the producer price index and the consumer price index. The figures for these indices are often based on independent sampling methods and are revised frequently. Whereas without the availability of continuous prices it is very difficult to trade vanilla options both in the American and European option styles.

3. Out of the money purchase: if a trader intends to purchase an “out of the money” binary option he would find it cheaper in comparison to an “out of the money” vanilla option purchase with the assumption that the strike price and the expiry time is the same. The difference is there because the binary option pays a fixed amount on the trade being “in the money” whereas the vanilla option theoretically pays an infinite amount.

4. Moving from out to in: the movement of a binary option from being “out of the money” to “in the money” is quite rapid as compared to the value movement in a vanilla option.

These are the major differences between the binary option and the vanilla option. However both the options have the similarity of no payment in case the trade stands out of the money at the time of expiration. Therefore with the differences given above the binary options trading is considered less risky than the standard vanilla option trading.