Binary Options: Strategies for Directional and Volatility Trading

CHAPTER 3

Pricing

Since a binary option can be settled at expiration only at $0 or $100, the price of the option will fluctuate between $0 and $100 until expiration. The price will fluctuate as a result of market transactions made by traders.

Just like all markets, the participants will make bids and offers to each other in order to trade each strike price of the options contract until expiration. There are a number of components that will be taken into consideration by market participants in order to determine the price of a binary option contract. Two key components are the strike price of the option and the time remaining until expiration.

STRIKE PRICE

As you learned earlier, the strike price represents a specific price condition for the underlying instrument. Each instrument will have multiple strike prices. For example, if the Standard & Poor's (S&P) futures are trading at 1200, there may be strike prices for 20 points up and 20 points down.

Exhibit 3.1 displays an option chain of the US 500 binary options strike prices.

EXHIBIT 3.1 Option Chain

Typically, there are strike prices available for two times the average daily range for each underlying security, both above and below its market price at any given time the market is open.

When traders purchase a certain strike price, they want the underlying instrument to be above that strike price at expiration so that they can ...