By Darrell Martin
In a previous article, it was explained what it means to buy an Out Of The Money (OTM) binary. This article will deal with the opposite: Selling an Out of the Money binary option. Although this can seem confusing at first, focus on the initial trade cost and the trade advantage compared to what happens when you are the buyer.
Remember, the binary options have an underlying market price and a binary strike price level. As the seller, you want the underlying market price to be trading below the binary strike level at expiration. If you are correct, the binary contract will settle at zero.
Remember, the binary price for each binary strike level will trade between 0 and 100.
This may sound backwards, but as the seller, you want the binary contract to settle at zero. This means the binary seller receives $100 per contract (fees not included). The seller is short the binary trade price. As the seller, you want the price to trade lower, subsequently settling a zero.
When initiating a binary options trade, the initial cost is always the maximum trade risk of the position. If you are selling a binary, the risk comes if the binary trade price goes higher. Maximum risk can be up to 100. The difference of 100 minus the binary trade price is always the initial cost to the binary seller, not including exchange fees.
When selling, an OTM binary means the underlying market price is above the strike level. As a seller, you want the price to drop down below the strike level.
The trade disadvantage for the binary seller comes the farther the underlying market price is above the strike level when initiating a trade. To transition from a binary trade disadvantage, the binary seller will have a cheaper initial cost and a higher trade price in the 0 to 100 binary price range.
The two binary strike prices listed below show that there are different prices available when the AUD/USD underlying is trading at 0.73309.
AUD/USD>.7320 bid price at 62.00
AUD/USD>.7300 bid price at 83.50
With the AUD/USD>.7320, the difference between the strike and the underlying current price of 0.73309 is about 10 pips. The spot AUD/USD has to sell off at least 10 pips at expiration. This is less of a disadvantage than the other strike. Because of this, there is a higher initial cost compared to the other strike. (100 - 62.00 trade price = 38.00 cost plus exchange fee.)
There is a bigger trade disadvantage if you choose to sell the AUD/USD>.7300. The difference between the .7300 strike and the current underlying spot of .73309 is about 30 pips. In order for the seller to be profitable at settlement, the spot AUD/USD would have to sell off over 30 pips at expiration. Even though at this strike level the initial cost is much less than the higher strike binary, it is because this strike is farther out of the money.
Taking the time to do a little research before you click the button to enter the trade can make the difference between a winning and a losing trade.