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 ETFs with binary options? Learn more about Binary options vs. ETFs here.
In this article, Binary options vs. ETFs, we will answer these questions. You will learn:
With this knowledge, you will be able to decide whether to use binary options or ETFs for your index trading.
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 ETF, 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.
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 an ETF.
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 ETF 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 or ETF. 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 ETF can easily eat up a few percent of your capital every year in management fees. Even a passive ETF 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.
Binary options allow you to invest in falling prices more easily. ETFs are based on the assumption that the market will rise, which is while they are mostly available in one direction – up. During a downtrend, this causes you to lose part of your money only to regain it later. Since a 50 percent loss requires a 100 percent gain to get you back to where you started, this procedure is less than efficient. With binary options, you can vary your investment more easily. During a downtrend, you can invest in a low option and make the same profit as during an uptrend. If making profit in any market environment is important to you, binary options provide a significant advantage. If you would like to forget about your long-term savings, however, you should go with ETFs to avoid having to monitor the market.
The answer to this question depends on your beliefs about the market. ETFs are based on the assumption that the market will always rise over long periods of time. The 20th century seemed to proof this theory by providing one record high after another and ever-flourishing markets.
Since the then, however, this theorem seems to be less self-evident. After the market crash of 1999, where many new-economy companies lost large parts of their market value, the market has moved mostly sideways and has failed to show the same tendency for continuous gains. Over the last two decades, the strategy of buy and hold would have failed to provide traders with long-term gains.
Now the big question is whether the last 20 years were just an anomaly or the new normal. Will the market soon resume soaring from new high to new high or will we be stuck in a sideways movement for another two decades?
Depending on your answer to this question, ETFs might be a useless investment. If you believe that the market will not rise over the long term or only rise slightly, investing in ETFs is the worst choice you can make. You would bet your retirement savings on an investment that is unable to generate considerable returns.
This is where binary options can provide a more flexible alternative. In the event of a market crash, binary options make it easy for you to profit from falling prices. Over the long term, binary options do not need rising prices to enable you to make profits, all they need is market movement.
If the market goes down, it goes down hard. That makes it easier to predict what will happen and allows you to win a trade. With ETFs, you lack a similarly easy way of profiting from down trends. If you still want to buy and hold ETFs over decades, you should nonetheless consider using binary options as an additional tool during downtrends. Winning a binary option that predicts falling prices could offset the losses these falling prices cause in your ETF, thereby increasing your long-term gains tremendously.
On first look, binary options and ETFs seem to be fundamentally different investment types, with one targeting long-term investors and the other short-term traders. On a closer look, however, we can find that both asset types can serve as your long-term investment tool.
You should choose binary options if these criteria apply to you:
You should choose ETFs if these criteria apply to you:
Based on these criteria, you should have a pretty good idea which type of investing is right for you. Enjoy investing!