When trading binary options, everyone’s goal is to hold the binary until expiration in hopes of receiving the most value at the binary settlement if it finishes in the money. For binary trading, it is probably wise to keep things in perspective by looking at the ROI of the trade and the time management of the position.
The previous article, Binary Option Tips – Exiting Binary Trades before Expiration, covers the focus of the binary trade return, but time management is equally important.
Probably the easiest way to get you to understand this message is to show an example. Let’s say a binary trader has a bullish bias on the underlying market and decides to buy a binary strike that is out of the money. The trader expects the underlying price to exceed the strike level at the end of the day when the binary expires.
An out of the money binary means the binary price is less than 50, and the more the underlying price is below the binary strike, the lower the price of the binary. Let’s say you bought the binary for 15. A lower binary initial cost means you would realize more profit out of the $100 settlement payout if the binary finishes in the money.
What does the binary trader do if the underlying price rockets well above the strike before expiration? For example, what if the binary is priced at 97 bid / no offer and the binary doesn’t expire for 6 hours?
Of course the binary is well in the money as the binary price reflects, but at this point you are really just trying to squeeze an additional $3 out of the trade. Your return on the position would be 546.7% if you close it early, compared to 566.7% receiving the settlement payout (fees not included).
Additionally, there’s always the chance that the market reverses direction. Six hours is a long time, possibly enough time for things to go bad. A related article on (gamma) describes the relationship of time getting closer to expiration, and how the percentage price change of the binary can far exceed the change of the underlying. . This is an important concept to understand if you’re planning on holding a binary position into expiration.
Futures, options and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results.