markets-droppingWhen selling binary options, you are predicting that the underlying price will be trading lower than the underlying price at expiration. The thought process is the reverse of buying a binary so it might seem confusing at first, but focus on the initial trade cost and trade advantage compared to the buyer.

Again for the binary option there is an underlying market price and a binary strike price level.

As a binary seller you want the underlying market price to be trading below the binary strike level at expiration, and if you predict correctly the binary contract will settle at 0.

A settlement of 0 means the binary seller receives $100 per contract (exchange fees not included). As a binary seller you are short the binary trade price, and you want the price to trade lower ultimately to 0 which can only happen at settlement.

With binary options, when initiating a trade the initial cost is always your maximum trade risk of the position. So selling a binary, the risk is if the binary trade price goes higher. The maximum risk would be up to 100, so the difference (100 – binary trade price) is always the initial cost to the binary seller plus exchange fee.

For a binary seller, an OTM binary means the underlying market price is above the strike level.

The farther the underlying market price is above the strike level, the more of a trade disadvantage the binary seller has when initiating a trade.

Remember binary pricing for each binary strike level will trade between 0 and 100.

So to transition from a binary trade disadvantage means that the binary seller will have a cheaper initial cost, and a higher trade price in the 0 to 100 binary price range.

Compare the two binary strikes below when the spot EUR/USD underlying is trading at 1.0833

EUR/USD >1.0820 bid price at 60.25

EUR/USD >1.0780 bid price at 85.25

With the EUR/USD >1.0820, the difference between the 1.0820 strike and the underlying spot EUR/USD at 1.0833 is 13 pips. That means the spot EUR/USD has to sell off at least 13 pips at expiration, which is less of a disadvantage compared to the other strike. For that reason, initiating a sell at this binary strike results in a higher initial cost compared to the other strike. (100- 60.25 trade price = 39.75 cost plus exchange fee).

The EUR/USD >1.0780 strike results in a bigger trade disadvantage for the seller as the difference between the 1.0780 strike and the underlying spot EUR/USD at 1.0833 is 53 pips. That means for the binary seller to receive the settlement payout, the spot EUR/USD has to sell off over 53 pips at expiration. For this reason, at this strike level the initial cost is much less than the higher strike binary because it is farther out of the money.

Futures, options and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results.