By Darrell Martin
A binary option is considered out of the money (OTM) when the trader is initiating the trade at a disadvantage. If selling, an OTM binary option would be where the underlying market price is above the strike level. As a seller, you need the underlying price to finish below the strike at expiration to finish in the money. The greater this differential, the greater the seller’s initial trade disadvantage and the greater the disadvantage, the cheaper the initial cost of the binary. This means that the seller’s price would be greater than 50.
If buying a binary, an OTM binary would be where the underlying market price is below the strike level. The greater this differential, the greater the initial trade disadvantage, which reflects a cheaper initial binary cost. For the OTM binary buyer, this quoted price would be less than 50.
OTM binary options have no intrinsic value, only extrinsic or time value. This binary option will expire worthless if it is still out of the money at expiration time.
When trading binary options, you are agreeing or disagreeing with a statement. In the image below, it shows an OTM strike for the statement: EUR/USD >1.1066 (9PM). To determine an approximate percentage of the probability that the binary has of expiring in the money, you can look at the bid and offer prices and take the average. This image shows the bid being 1.75 and the offer being 10.00. A rounded average is 6 meaning you have a 6 percent chance that the EUR/USD will be above 1.1066 at the expiration time of 9 PM.
The current indicative index reflects the underlying market price is 1.10563. Only take this trade if you have reason to believe the market can move from 1.10563 to over 1.1066 by expiration. An order ticket shows Max loss is $10.00 and Max profit is $90.00, so you may think you like the odds of risking $10 to make $90.
Actually, you like the return or the possible Max profit, but you do not really like the odds because you only have a six percent chance of this statement being true and finishing in the money at expiration.
The only way for an OTM binary option to be profitable is for the market to move in the direction of your trade, whether you are buying or selling. OTM strategies do not require a stop because of the low risk trading. In the forthcoming articles in this series, the strategies of scalping on five-minute binaries and strangles will be discussed.
