What does at-the-money mean?
What does at-the-money mean?
At-the-money, in-the-money, and out-of-the-money are terms that describe the relationship between an option or binary option and the underlying market that it’s based on. For Nadex Binary Options, these terms specifically refer to the indicative price, and whether it's at, above or below the strike price. If the Nadex indicative price is equal to the strike price of the binary option, the option is said to be 'at-the-money'.
In-the-money and out-of-the-money
Nadex Binary Options that are based on stock indices, forex and commodities markets pose the question:
Will this market be above this strike price at expiration?
This means that if you buy a binary (or any) option based on these markets, you want the indicative price to be above the strike price at expiration. In other words, you want it to be in-the-money.
If you sell a binary (or any) option based on these markets, you want the indicative price to be at or below the strike price at expiration. In other words, you want it to be at-the-money or out-of-the money.
If you buy a binary option that expires in-the-money, you receive the full payout of $100.
Buyers of binary option contracts based on stock indices, forex, or commodities markets that finish at-the-money will not receive a payout. A contract would need to move one increment (cent, tick) higher to be in-the-money and get the full payout for the buyer.
To put it another way, buyers of stock indices, forex, or commodities binary option contracts that expire at-the-money will receive a zero payout and the seller will receive the $100.
Binary options based on events work differently as the contracts' payout criteria is 'greater than or equal to'. This means a contract that expires at-the-money will also receive the full $100 payout.
Extrinsic and intrinsic value
Before expiration, an option has extrinsic value, which reflects how likely it is to expire in-the-money. It may also have intrinsic value, if the market price is already above its strike price.
An in-the-money option will have a higher price than at- or out-of-the-money options, because it has both intrinsic and extrinsic value. The market price is already above its strike price. As long as it stays there, the in-the-money option will get the full payout.
At- or out-of-the-money options need the market to move further up. They have no intrinsic value and less extrinsic value, since they have a lower probability of expiring in-the-money than an option which is already in-the-money.
Exiting trades before expiration
Remember that you can exit a trade prior to expiration and receive the current bid or offer value of the contract. If you bought the binary, you will sell at the bid to exit. If you sold to enter the trade, your exit order will be a buy at the current offer.
This is true regardless of whether an option is at-, in-, or out-of-the-money. For example, you could buy an out-of-the money binary and sell it for a higher price while it is still out-of-the-money. Or you could sell an in-the-money option and exit as the market drops to just around the strike price. Your profit or loss is always the difference between the amount you paid to enter and the amount you receive upon exit.