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If you understand the advantages and disadvantages of option prices being In the Money (ITM), At the Money (ATM) and Out of the Money (OTM), you can better choose the right priced option to fit your strategy.
This, in turn, will help you to increase your profits and decrease your risk. There are two conceptual parts that make up the price of an option; extrinsic and intrinsic value.
What does “at the money” mean?
The values of both parts and the speed at which they rise and fall, depend on where the underlying market price is trading at in relation to the strike price of the option, what the implied volatility is, and the amount of time until expiration.
This determines if their bid and ask prices are ITM, ATM or OTM.
In this three part series, we will go over each one, and when the best time is to trade each one.
The technical definition for “At the Money” or ATM is, when the underlying market is at the same price as the strike price of an option it is at the money, ATM.
In the case of a Nadex binary, since they are worth $100 in total, when the underlying market for the instrument is the same price as the binary’s strike price, the binary will be priced around $50.
Well, if the underlying market is right at the strike price, what is the probability of it being the same price in two minutes, two hours, two days?
It’s 50/50; it has a 50% chance of going up and a 50% chance of going down. Therefore, the price of the binary is around $50 when it’s underlying market is at the binary's strike. In a previous article, we examined and showed how the price of a Nadex binary reflects the probability of it expiring ITM and profitable.
Related Link: How a Nadex Binary Price Reflects Probability of Expiring In The Money, ITM
To generalize it, when the binary is ATM, the price of the binary will be right at $50 at the mid-price.
What’s the mid-price? The mid-price is the middle between the bid and the ask or offer price of the binary. When the market is right at the strike price, you may have a $47 bid and a $53 ask, or something close to that, so the mid-price will be almost $50, if not exactly $50.
The bid and the offer will tend to be tighter with less of a spread in the mornings, when the market is more liquid and has more volume.
Passage of time and its effects on the delta
The spread being the amount between the bid and the ask. Also, the binary price is not based on the derivative’s indicative.
It is based on the actual underlying market price.
However, settlement is determined on the indicative.
Nadex posts the indicative in the tickets of each instrument and in an indicative list in their platform. For the underlying market, you need to see an actual underlying chart of that specific Future or Spot Forex chart, which is what the binary’s price is based off of.
Understanding the Delta on Binary Options
In the image below, you can see that the Nadex Binary contract for the USD/JPY is At the Money.
The bid side, if you were going to sell, is on the left. The offer or ask price, if you wanted to buy, is on the right.
You can also see the Nadex indicative for this contract is highlighted on the trade ticket. Along side of it is a Ninja Trader chart with live data.
To view image, click HERE
Trading activity tends to be high when the binary is ATM, thereby making the price move quickly at this point.
This can be an advantage or a disadvantage. It’s an advantage if it moves quickly to profit.
However, it can also be a disadvantage, as it can be more difficult to manage risk when the price moves quickly against your trade.
There is no intrinsic value in an ATM binary, it only has time value. Compared to an ITM binary, it has less overall risk because the price to enter the trade is less.
Although compared to an OTM binary, (where the underlying market price is not near and hasn’t reached the binary strike price or the direction your trade is going), you would be taking on a bit more risk because the price to enter is higher than an OTM binary or option.
With Nadex binaries, you can exit at any time giving you the option to manage your loss.
Apex Investing provides members risk management tools from their free Binary Scanner, to use while trading Nadex. Traders have a real advantage utilizing the many tools from Apex Investing to help with exiting and managing loss using the Binary Scanner.
If you expect the market to move in your direction, then an At the Money binary is a good choice. You can make $25 quickly on one Nadex Binary because ATMs tend to move fast, so be sure to set a take profit.
ATMs can also move against your trade quickly, so you want to be prepared to exit and manage loss. However, be warned that on ATM binaries, exits are very difficult to manage the closer you get to expiration.
To learn more about how to trade binary options in-depth and for binary options signals, trading strategies, tools and trade rooms see ApexInvesting.com.
The preceding article is from one of our external contributors.
In the money & out of the money
It does not represent the opinion of Benzinga and has not been edited.
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