By Darrell Martin
Binary options have Out of the Money (OTM), In the Money (ITM), and At the Money (ATM) offerings and as a trader, you can choose to buy or sell any of the contracts offered, depending on the position you want to take. The binary option has an underlying market price and a binary strike price level. This article will focus on buying an OTM binary option.
If you choose to be a binary buyer, at expiration, you are predicting that the underlying price will be trading higher than the particular binary strike price level. If you are correct at expiration, you will receive $100 per contract, exchange fees not included.
If you buy a binary strike that is above the underlying market price, you are buying an OTM binary. At expiration, the underlying market price has to be trading above the strike in order for the binary buyer to receive the settlement payout.
When initiating a trade, the trade disadvantage comes the farther the underlying market price is below the strike level. The price of a binary will always be between 0 and 100.
To transition from a binary trade disadvantage, the binary buyer will have a cheaper initial cost or a lower trade price in that 0 to 100 price range.
Two binary strikes are shown below for the USD/JPY. The underlying is currently trading at 107.380.
USD/JPY>108.00 offer price is 12.25 USD/JPY>107.60 offer price is 35.00
For the USD/JPY>108.00, the difference between the strike and underlying trading price is 62 pips. For this contract to be profitable, the USD/JPY market would have to move at least 62 pips. This is a big disadvantage when compared to the 107.60 strike.
The USD/JPY>107.60 strike has less of a trade disadvantage. The difference between the 107.60 strike and the currently trading underlying price is only 22 pips. To receive full profit at settlement, the USD/JPY would only have to rally more than 22 pips. Yes, this strike is priced higher, but it is more advantageous to the OTM binary buyer as there is not as much movement needed in order to be profitable.
Be sure to examine your strike prices before you enter a trade. Doing so will help set you up for more profitable trades.