When picking the proper binary strike you need to take into account the time expected for the underlying trade setup compared to when the binary expires. Also important is the differential between the underlying price and the strike and how much is the initial cost of the binary which impact the potential profit if the binary finishes in the money at expiration. Understanding and knowing this information is critical to becoming successful when trading binary options.
Picking a strike too far away from the underlying or picking a strike too close to the underlying can produce unintended results. The sweet spot is what you should aim for, meaning you will get the most for your initial investment and maximize the potential ROI.
Looking at the SP 500 binary ladder below which the contract is based on the CME E-mini S&P 500 future, you will see multiple ITM and OTM strikes. Each strike level displays the best bid/best offer where you can either buy or sell the binary depending on your underlying market bias.
Remember when you buy the binary your initial investment is the price you paid, and the potential profit is the differential between binary price and the binary expiration value of $100 per contract.
If you sell the binary, you are anticipating the underlying market price to trade lower and ultimately have the binary settle at zero where the differential between the binary trade price and zero is your profit. Your initial cost which is always your maximum trade risk would be the opposite direction differential or trade price and 100.
That being said, looking at the trade ticket below, you can see purchasing the US 500 (SEP) > 2066.50 binary expiring at 4:15 on June 17th requires an initial investment of $45 with a maximum profit of $55. If you were to reverse this trade and sell the binary, your initial cost would be $55 with a maximum return of $45.
Now that you have pricing methodology fresh in your mind, look back up at the binary ladder, buying an ITM binary of say 2054.50 will cost $66.75 initially and return $33.25 if the underlying closes over the 2054.50 strike. Using this strike you have 8 full points of edge where the underlying price is over the strike and you are paying for this initial advantage.
If you don’t want to have that many dollars at risk you can just move to a higher strike if you trade bias is bullish. Moving your strike selection up to the 2078.50 strike would allow you to risk less initially, $26 and potentially be rewarded with $74 if the underlying closes over 2078.50, which is very close to a potential 2,080 target.
If you were thinking the underlying could have an even a bigger upside move within the time frame of the option you could look at the 2090.50 strike. Obviously if this binary strike finishes in the money at expiration, the potential ROI is going to be much higher but the likelihood of this happening is a real stretch. As you can see from the quotes the market is putting less than a 10 percent chance that binary will finish in the money.
As you can see there are lots of choices when trading binary options and many trade offs to consider.
Note Exchange trading fees not included in calculations