The strike price of an option or binary option is compared against the current market price to determine the option’s value, both at and before the option’s expiration.
The common terms “in the money” and “out of the money” refer to the relative positions of the strike price and the price of the underlying market:
- In the money means the market is above the strike price
- Out of the money means the market is below the strike price
The relationship between market price and strike price also determines the outcomes for buyers and sellers at expiration:
- If the market price is above the binary option’s strike price at expiration, the buyer gets the full $100 payout.
- If the market is at or below the strike price, the seller gets the payout and the buyer gets zero.
Thus, the buyer wants the binary option to be in the money at expiration, with the market above the strike price, so the binary will return the full value of $100 to the buyer.
In, at, and out of the money
Every binary option is based on the question:
Will this market be above this strike price at expiration?
Buyers expect the answer to be yes and sellers expect the answer to be no. In other words:
- If you buy a binary (or any) option, you want the underlying market 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, you want the underlying market 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.
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. In-the-money options also have intrinsic value, because the market is already above the strike price.
An in-the-money option will typically have a higher purchase price than at- or out-of-the-money options, because it has intrinsic value. The market is already above its strike price. If it remains in the money at expiration, the option will get the full $100 payout.
Possible advantages to buyers and sellers
A trader may choose to sell an in-the-money binary option if they believe the market will go down and the binary will end up out of the money and expire at zero. That outcome would let the seller receive the full $100 value as profit.
For buyers, in the money binary options may offer higher probability (at the time of purchase) of expiring in the money, since the market is already above the strike price. In exchange for that edge, the buyer will typically have to pay more to buy the binary, since the price reflects that edge. That means a higher initial risk in exchange for that probability advantage.
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.