What does out-of-the-money mean?
Out-of-the-money, at-the-money, and in-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.
For the buyer of a binary option, if the strike price of the binary option is above the current price of the underlying market, the binary is said to be 'out-of-the-money'. The market price is still outside the price zone in which the binary would have full value at expiration. Thus, the buyer wants the market to go higher.
In-, at-, and out-of-the-money
The buyer of a binary option that expires out-of-the-money will receive a zero payout and the seller will receive the $100.
If you buy a binary (or any) option based on stock indices, forex, or commodities 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 stock indices, forex, or commodities 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.
A binary option that expires in-the-money gives the full payout of $100 to the buyer. An out-of-the-money binary will not.
Nadex events contracts that expire at-the-money will receive the $100, as well as events contracts that expire in-the-money. However, binary options based on stock indices, forex, and commodities markets only receive the $100 payout when they expire in-the-money. Strikes for these markets pose the question:
Will this market be above this strike price at expiration?
Extrinsic and intrinsic value
During the life of the contract, prior to expiration, a binary option will usually be cheaper to buy when it is further out-of-the-money.
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 is already above its strike price.
An out-of-the-money option will have a lower price than at- or in-the-money options, because it has no intrinsic value. The market is still below its strike price. If it remains out-of-the-money at expiration, the option will get a zero payout.
Possible advantages to buyers and sellers
A trader may choose to sell an out-of-the-money option if they believe it will remain out-of-the-money and expire at zero, allowing the seller to receive the full $100 value as profit.
For buyers, out-of-the-money binary options may present lower risk, since they are generally less expensive.
In either case, traders don’t need to wait for expiration. If you buy or sell at one price and the option’s value moves in your favor, you can exit before expiration to take profit.
Exiting trades before expiration
If you exit a trade prior to expiration, you will 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 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.