How to Choose an Option Type

Choosing an option type to trade is one of the most important decisions a new trader has to make. To make a good choice, there are a few things you need to know.

The rules of how to choose an option type

At first glance, it might seem as if choosing an option type would be easy. There are, however, quite a few hidden implications and effects of this decision that can cause a bad decision to potentially ruin you. In our analysis we will compare high / low options, boundary options, and one touch options. Some brokers also offer exotic binary option types, but these option types are too rare to deserve a thorough analysis.

Here are the main points you should consider when choosing an option type:

Continue reading below the table…

Risk involved

Regarding how much risk is involved in an option, all option types vary greatly. High / low options are the least risky form of investment. With this option type, all you have to do is predict whether the market will rise or fall over a given period of time. Even if you know nothing about financial markets, simply by playing the odds, you are guaranteed to win 50% of your trades.

With a little knowledge of financial markets and technical analysis, knowledge you can get here on, it should not be too hard to increase this winning percentage. Depending on the payouts your broker offers you, you need to get to a winning percentage of roughly 60% to 65%. This is not too much to ask for. If you are committed to learning, you can easily do this.

In other words: Trading high / low options involves the least risk of all option types. For some trader personalities, this is perfect. For some traders, however, it is dangerous.

Trading a safe asset is reflected by the possibilities this asset can generate. While it is not that hard to make a profit with high / low options, this profit will always be smaller than what you potentially can make with other asset types, mainly boundary options and one touch options. These assets, on the other hand, involve a lot more risk.

With one touch options or boundary options, you will win less trades than with high / low options, but receive a higher payout. For some traders with a certain personality, this is the better option. For them, trading high / low options would seem like a numbingly slow process with too little return. They need something more exciting.

If you feel this way, it is important to not suppress these feelings. When you do suppress them and start trading high / low options, they will sooner or later cause you to make mistakes and can potentially ruin you. Choose the asset that suits your character and you will be fine.

Psychological stress level

Traders who trade high / low option will be right most of the time. Traders who trade one touch options will be wrong most of the time. Traders who trade boundary options will be somewhere in between. This causes fundamentally different psychological stress levels. As a trader of one touch options, you have to suffer through a few losses before you can hit a big win. Positive reinforcement is rare and your strategy resembles a gold digger’s approach: You are always looking for the next nugget that will make you rich, but you have to dig through a lot of mud before you get there.

While some traders find this approach exiting, sometimes even adventurous, it is not for everyone. Before you choose an asset, ask yourself if you can stand the stress of having had a few losing trades and needing a big win without abandoning your strategy. If you cannot, it is better to stick with high / low options, which will trades more regularly.

Your strategy

Depending on which strategy you trade, your strategy might determine the option type you have to use. While most strategies allow you to use different option types, some strategies such as the straddle strategy should be traded with a certain option type. In case of the straddle strategy, this would be boundary options.

If you are determined to trade a specific strategy, you have to use the option type this strategy requires. If this option type does not fit your tolerance of risk or stress level, you need to choose a different strategy.