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Understanding Binary Options Pricing

Author Zizzur Staff. Published on August 20, 2011 - 8:04 pm (565 views — 435 words)

Studying the binary options pricing is an effective way to understand the dynamics of binary options trading. Binary options trading is made up of a variety of components like a strike price, expiration date, and an underlying commodity, unit, instrument, or security price. In binary options trading, option contracts are put on the market up front for a premium payment. Furthermore, there are also the call and put options that serves has an important function in binary options pricing.

One thing that you need to know about binary options pricing is that it features a fixed payout rate. This is what distinguished binary options trading from vanilla options. For instance, you purchase a call option on the movement of a certain instrument, you can gain up to 70% of your investment, even if the price of the underlying commodity is just 0.0001 over the strike price. Even though the earning that you can gain from a vanilla option is a potentially unlimited variable amount, it is still based on the to what degree of the underlying asset clears the strike price. This implies that in binary options trading, any investment, even those small ones, has a chance to earn a relatively bigger profit constantly. The fixed payout scheme also means that the risks will be computable and more bearable.

In order to fully understand the dynamics of binary options pricing, here is a hypothetical example. A binary options contract X features a strike price of $50, an expiration time of 4pm, and a contract size of $100. The trader is faced with two selections: predict that the instrument will exceed the strike price and get call options contracts, or believe that it will not reach the strike price and opt for the opposite put options contracts instead. For this case, the investor gets 10 call options contracts for $30 each, which means that it has a total cost of $300. This will be the overall risk for this trade as it would be all the money that the trader can potentially lose. If the expiration date comes and the value of the instrument is over $50, then the trader will be given $1,000, but you also have to consider the total cost of the contracts which is $300. The investor then acquires a total gain of $700.

However, remember that times dynamics also plays a huge influence on binary options pricing. This means that as the value of the asset goes nearer into the money as it approaches the expiration date, the price of the contract also goes nearer to the contract size as well.