By Darrell Martin
At expiration for a binary option, there can only be two possible outcomes. You are either right or wrong on your market view and there can be only two possible payouts. If you are correct, you get $100 per contract. If you are not correct, you get zero. Some traders call it All or Nothing.
When you enter a binary option trade, you are saying either you believe a statement will be true or it will be false. It is as simple as that.
Let’s say you are watching your charts and checking the news and feel the AUD/USD currency pair should be strong the remainder of the day. There can be many choices with different risk-to-profit scenarios but you feel comfortable and agree with this binary statement: AUD/USD>.7160 (7PM).
By agreeing with the binary statement, you are buying the binary option of that particular strike.
This means you believe that the underlying AUD/USD market price will be above .7160 at 7:00 PM ET, not trading at or below .7160, but trading above. At expiration, for the binary to finish in the money, the underlying has to be trading above the binary strike level.
The image shows the order ticket that you buy the binary at the price of 77.25, which has a profit potential of $22.75 for a cost or risk of $77.25 per contract. Some traders may think that it is too much risk for the potential profit but remember at this particular binary strike you are paying for the initial trade advantage. The price of the AUD/USD currency is over the strike level by 10 pips (0.7170-0.7160).
If the underlying AUD/USD sells off and trades below the strike at expiration, your contract is worthless. The initial trade advantage when initiating the trade vanished and the initial cost of $77.25 per contract would be the trade loss. (Note: exchange fees are not included in calculations.)
In addition, you don’t always have to wait until the binary option expires. You can close out your binary position prior to expiration to either cut your losses or take an early profit.
Tip: Remember when figuring out your potential profit and your risk, when you buy a binary, the price you buy for is your risk and 100 minus that price is your profit potential.