The longer you're involved in the world of investing, the deeper down the investing rabbit hole you can go, maybe even so deep that you reach the concept of binary outcomes. Beginner investors may find the concept easier to understand than the myriad outcomes possible with traditional stock and bond trading. Let's walk through what this term means and how it applies to investing.
What is a binary outcome?
Strictly speaking, a binary outcome is a situation where only two outcomes are possible: yes or no. (For investors, perhaps it's better to use win or lose.) When choosing an investment with binary outcomes, you're less worried about things like multibaggers and stock splits and much more about whether you're right or wrong about something specific.
This can apply to different kinds of investments. Start-ups often come with binary outcomes baked in since they have just one product or service they're hoping will make the company worth buying into. But there are other choices, too, like binary options trading.
All-or-nothing expectations
No matter what you're investing in, when trying to decide whether you're dealing with a binary outcome, the key is whether you have an all-or-nothing expectation about some fundamental part of the investment. Binary options are very clearly defined as all-or-nothing investments, but other investments can have binary outcomes, too.
For example, if you're looking to invest in a start-up with a singular product in development, you're banking on that product to hit. If it does, the stock will soar; if it doesn't, it will be worthless overnight. This is always the gamble with small start-ups: huge upside potential, but their all-or-nothing nature makes the risk even greater.
This is different from traditional stock or bond investing, where your main bet is that the value will increase incrementally over time. That's the entire goal. You aren't worried about whether one thing will happen or not happen in one moment; you just care that it keeps having little wins and growing slowly over time.
Binary options trading
Binary options are the most common investing instrument where people really think heavily about binary outcomes. They literally require you to make a yes or no decision. If you're right, you make money. If you're wrong, you lose everything that you staked. Binary options are generally very short-lived, often just hours long, and have very limited and specific terms.
For example, at noon, you might buy a binary option that the value of a share of XYZ Industries will be worth $50 at the close of the market. If you're correct, you receive a payout based on the contract you signed, and if you're incorrect, you lose all the money you staked. It's a very simple transaction at the root of the thing (though how you determine the odds of the outcome of the option can be more complicated).
Binary options have been legal securities in the United States since 2008 and are traded on both regulated and unregulated exchanges. Here at The Fool, we always encourage you to trade on regulated exchanges -- no matter what the unregulated market may promise you. Unregulated exchanges for binary options are classic places to get scammed and have your identity stolen.
Pros and cons of binary options
Binary options can be an easier way for investors to get into thinking about stocks and how they work, but they don't come without risk. In fact, the risk is massive, since you have no ownership potential of any sort of asset or any protection beyond what a regulated exchange offers. That basically extends to protecting your identity and ensuring you get paid fairly for any positive outcomes.
Like most standard investments, binary options have fixed risk, which is generally everything you stake on your options. It's also possible for stocks to go to zero, though they're far less likely to do so before you have had many opportunities to sell and salvage some of your capital.
They also ask you one simple question, which may look like "Will this stock reach X by Y o'clock?" or one of many more complicated variations.
Related investing topics
The idea of binary options can be very appealing to beginning investors. However, the fact that you don't retain ownership of any of the stocks where you've bought options means that they really do go against The Motley Fool's long-term buy-and-hold philosophy.
You will not see us recommend binary options. Although we may, from time to time, suggest stocks that offer other types of binary outcomes for investors.
About the Author
