If you are new to the binary option trading world, the title of this article may seem a little complex but eventually it is really simple. Let us quickly explain you the mechanism of buying Out-of-The-Money binary options and the advantages associated with such strategy.
The three stages of an option
At any point in time between the opening of an option position and its maturity, the option can be at three different stages: Out-of-The-Money (OTM), At-The-Money (ATM) and In-The-Money.
Out-of-The-Money (OTM) – An option is deemed Out-of-The-Money when the position is losing money. It then corresponds to the conditions where the underlying asset price is below the strike level for a Call or High option, and the conditions where the underlying asset price is above the strike level for a Put or Low option.
At-The-Money (ATM) –This corresponds to the conditions where the underlying asset of your option is at or around the same level as the strike price.
In-The-Money -This corresponds to the conditions where your option is generating a profit. It then corresponds to the conditions where the underlying asset price is above the strike level for a Call or High option, and the conditions where the underlying asset price is below the strike level for a Put or Low option.
The key differences between binary options and traditional options
One key difference between traditional options and binary options is that you have to select a strike for traditional options. The strike corresponds to the price at which you will have the right to buy / sell the asset at the expiry of the option. As you can then guess, the higher the strike for a Call option (that gives you the right to buy) the lower the price while the higher strike for a Put option (that give you the right to Sell) the higher the price. With traditional binary options (High / Low binary options), the strike corresponds to the price of the underlying level at the moment you open the position and is refreshed every couple seconds.
Some brokers enable you to trade different binary option strikes
Some brokers, such as IG Binary, Anyoption with the 0-100 Binary and Interactive Option with ladder options let you choose between different strikes. The strike is no longer the current price of the underlying as it is by default with most binary options brokers. In simple terms, if you buy a Call with a strike that is above the underlying market price or a Put with a strike that is below the underlying market price then you’re buying an Out-of-The-Money binary option.
As you can guess, the further out of the money the option is, the higher the return. It means that for a call, if you chose the option with a strike higher than the current price, the proposed return on this call will be higher than the proposed return on a call with a strike that is equal to the current price. This is because the underlying asset needs to increase much more in the first case in order to make a profit. The broker thus rewards you with a higher return to compensate for the higher risk you take. Returns with Out-of-The-Money binary options can reach up to 1’500% but of course these transactions are much more risky than traditional binary trades.
Examples and advantages of Out-of-The-Money binary options
Let’s compare two strategies with two different binary option strikes. Let’s pretend that the live EURUSD price is 1.35673 and we are bullish on the euro. We consider two different High binary options with strikes 1.35677 (At-The-Money) and 1.35772 (Out-Of-The Money), with maturity 10 minutes.
- The At-The-Money High binary option with strike 1.35677 and maturity 10 minutes offers a potential return of 81%
- The Out-Of-The Money High binary option with strike 1.35772 and maturity 10 minutes offers a potential return of 267%
The second trade is at a price disadvantage to the first since the EURUSD has to increase more to reach the strike and turn your option In-The-Money. This additional risk is compensated with a far greater return of 267%. If you bet $100 on the second option and the EURUSD rise above 1.35772 after 10 minutes, you end up with a quick 267 dollar profit. This strategy is great for experience traders that want to use binary options at their full potential and leverage their cash deposit. If you are just starting with trading, you should first try to buy safer strikes and learn about binary options before you enter these kinds of trades.
Don’t hesitate to have a look at our detailed review of the Binary 0-100 options with Anyoption or our test of IG binary and use our secure links to access the broker websites and buy your first Out-of-The-Money binary option.