A binary option, also called a digital option, is an option with only two possible outcomes in terms of the profit: if the option expires in the money, the option holder receives a certain sum (or asset), called the notional, otherwise the holder receives nothing.
Binary options are usually european, however sometimes american binary options, so called one-touch options, are traded.
Binary option value graph is similar to the delta graph of a vanilla option, similarly, the delta graph of a binary option looks similar to the gamma graph of a regular option.
A binary option can be roughly simulated with a portfolio of two vanilla options with very close strike prices. In this example we use a portfolio of 1000 long calls struck at 9.999 and 1000 short calls struck at 10.000 to emulate a binary call with the notional of 1 (1000 * 10.000 - 1000 * 9.999) and strike 10.
Want to learn more? Download now an interactive reference application for iPhone.
The screenshot shows the following portfolio:
European call struck at 9.999 with expiry in 30 days
European call struck at 10.000 with expiry in 30 days
This is an excerpt from iOptioneer option trading reference application. In order to build the real-time dynamic strategy graph and run simulations you will need to download the application from App Store.