By Darrell Martin
In a previous article, the significance of knowing the difference between In the Money, At the Money and Out of the Money was presented. It spelled out as well, when the strike is trading right around the current underlying market price, that binary’s strike is worth around $50. These are imperative factors to consider when choosing the right binary option.
There are times in any trader’s career when you may be tempted to trade simply based on the risk. When you choose based on the price you are willing to pay, or the risk, you are really choosing based on emotion. You are choosing because you do not like risking too much money. Suppose you first look at the price ladder offerings at Nadex such as the one below.
You decide based on what you see that you are willing to risk $20.75 to make $100. That sounds like a good deal! However, if you step back and take a minute to understand a couple of things, you will save yourself some money and some heartache. Look at the bid and the offer prices in the purple box. Bid is 11.75 and offer is 20.75. The mid-price is the point in the middle of the two prices shown. To get the mid-point, you can “eyeball” it, or you can simply add the two together and divide by two. In this case, the mid-price is 16.25. This is your percent probability of winning on this trade. To make it even more simple to understand, let’s remove any decimals in the numbers. You may think that you are only risking $20, but if you are only winning 16 percent of the time, do the math! You are winning one and losing five. If the max profit is $80, but you are losing $20 five times, you end up losing more than you profit. Look at the midpoint or mid-price for the probability. A look at the chart will show you just how far the market will have to move in order for it to be profitable.
Depending on news, time and other factors, it may happen. However, based on probability, it only has a 16 percent chance of moving that far before expiration. You have a greater chance of losing $20. Maybe you still think that is risking too much. This is a wonderful thing when trading with Nadex. You can exit early to take profit or protect your loss. A good strategy would be to exit if the market dropped down and hit your strike. Changing markets, suppose you bought AUD/USD >.7642 (12AM) for 70. The market is currently at .7644. Since you know that the current strike is priced at around 50, if the market drops to your strike price of .7642, it will be priced around 50 and you can exit. Your loss will be about 20, but you have a greater probability of winning by buying a strike that is already above the market. By taking a higher probability binary option strike and creating an exit point, you lower your risk.