By Darrell Martin
A binary option contract is simply a statement. It is a true/false or yes/no statement. If you believe the statement will be true at settlement, you buy the contract. If you believe it will be false, you sell.
Suppose you are consulting your charts and determine your position, whether buying or selling. You open up your Nadex account to find the contract that fits your trading position. When you click on it, a ticket will open. Look at the following image for this example.
The statement is EUR/USD >1.1161 (3 PM): The EUR/USD will be greater than 1.1161 at 3 PM ET. Since the indicative is 1.11654, the statement is already true. Notice the max loss (risk) and max profit (reward). If the contract was bought and the market didn’t go up anymore, simply staying where it is, this trade would be profitable.
Don’t look at binaries as the market has to go up or it has to go down. As long as the statement is true at settlement, the market can stay where it is, move slightly down or move up and the bought contract will remain profitable.
You may wonder why some contracts have prices around 70 while others are priced about 20. On the ticket above, notice its offer price of 77.50 is closer to 100 because the statement is already true. This is an in the money (ITM) binary because the market is already above the statement or contract price.
Looking at the image above, notice that the current market (indicative) is 21056.2. The >21043 contract is already true since the market is above that number. In order for the >21079 contract to be true, the market needs to move more than 20 points in the next one hour and ten minutes. For the >21043 contract, there is a much higher probability that the statement will expire true because it is already true. The >21079 contract has a much lower probability of expiring true because it requires the market to move.
The pricing of binaries does not take into account the direction of the market, where the market is going, what strategies you are using or what your charts and indicators show. It is merely from a pricing and probability standpoint. It compares the current market (indicative), to the strike price and then comes up with a pricing model. The pricing model can serve as a probability or a percentage.
The average of the bid and offer prices will give you a percentage or probability of the binary expiring above the strike. If you are selling a contract, you can use that average in reverse to say that the binary has that much of a percentage or probability of being false. To clarify, suppose you sold a binary for $20. You can say that it has a 20 percent chance that the statement will be true and an 80 percent chance that the statement will be false. In this example, you have a higher percent chance of being right if you sell.
This should help you understand why Nadex offers so many different contracts or strike prices. Don’t overcomplicate the binary. Understand that it is a true or false statement with a percentage built right in to aid you when trading.