Binary options vs. ETFs: Which is better?

Currently, ETFs are the standard way for traders to invest in the entire market. There is, however, a new challenger: binary options promise to make trading the market as whole simpler and more profitable. Are these promises true? Should traders replace their with binary options? Learn more about Binary options vs. ETFs here.

In this article, we will answer these questions. You will learn:

• Binary options vs. ETFs: Which is more profitable?
• Binary options vs. ETFs: Which is more flexible?
• With this knowledge, you will be able to decide whether to use binary options or ETFs for your index trading.

Basic characteristics of both investment types

ETFs, which stands for exchange-traded funds, are investment funds that are traded on a stock exchange. Based on predefined criteria, these funds select specific stocks and other assets and bundle them in one, thereby making it easy for you to invest in an entire industry or stock index by buying a single asset. The most common form of ETFs is based on stock indices, which many traders use to make long-term investments that are meant to provide for their retirement.

Binary options used to be ultra-short-term investments with expiries of only a few minutes or hours. Since many brokers now also offer long-term binary options with expiries of up to a few years, binary options have become a legitimate alternative to ETFs for long-term investors.

With binary options, you can also invest in indices, stocks, currencies, and commodities. You predict whether the market will rise or fall over a given period of time, and if you are correct, you get a predefined payout.

There are also more complex predictions you can make. You can, for example, predict that the market will reach a predefined target price, that it will escape a predefined price corridor, or that it will close above or below a faraway target price.

Binary options vs. ETF: Which is more profitable?

In terms of profitability, binary options and ETFs follow a fundamentally different approach. While ETFs create the same profits as the index they are built on; binary options have decoupled their profits from the index.

To understand this difference, let’s look at an example. Assume that the S&P 500 has risen 3 percent over the last year. In this case, an ETF based on the S&P 500 would have increased 3 percent in value, too. A binary option on the S&P 500, however, could have made a profit from around 75 percent to 80 percent.

This higher return is possible because binary options offer a predefined payout. You predict what will happen, and your broker offers you a predefined payout if your prediction comes true. On average, these payouts are around 75 percent, which means that you can make a lot more money with a correct prediction than you would make with it.

The downside of this system is that you will lose your complete investment if your prediction fails to come true. It is therefore absolutely essential that you never invest all your money on a single binary option. Instead, binary options require diversification.

If you invest only 10 percent of your money in a prediction on a stock index, a payout of 75 percent on these 10 percent would still net you a return of 7.5 percent, which would be much higher than what an would get you. At the same time, you still have 90 percent of your money available for other investments, for example in real estate, bonds, or other binary options. With a hybrid strategy that uses binary options as an addition to other forms of investment, you can get the return of an ETF while still having most of your money available.

Additionally, binary options are free from fees. An actively managed can easily eat up a few percent of your capital every year in management fees. Even a passive is not completely free. With binary options, there are no fees, and you can keep all your profits. While this should not be the deciding factor for which type of investment you prefer, it is an important factor in long-term profitability. Some banks offer ETFs with a management fee of 2 percent every year, which almost guarantees that these fees will eat up your profits the long run.

Signe J. Petersen is an experienced trader of stocks, currencies, commodities and many more. In the wake of rising popularity of binary options trading.