Understanding ITM Options – Part 1

Understanding ITM Options – Part 1

In today’s article we will begin to examine some of the specifics concerning in-the-money (ITM) binary options. These options are considered ITM when the binary strike bought to open is underneath the current market price or sold to open above current market price.

Understanding ITM Options – Part 1
Understanding ITM Options – Part 1 Getty Images

Like any type of option, ITM’s have their own list of advantages and disadvantages; and their appeal will depend on the trading personality you have or may wish to develop. In the past several articles, as we looked at out-of-the-money binary options (OTMs), we considered that their benefit was lower cost and higher reward, while their drawback was lower probability. With ITM options, the benefits and drawbacks are reversed.  ITM options are theoretically considered to offer a higher probability of success; therefore their cost will be higher, and returns lower.

Because of the higher probabilities, ITM options often appeal to traders; but it is important to keep in mind that just because ITM’s are considered more probable does not mean they are suitable for every trade or strategy. The factor that traders must consider with ITM’s is that the amount risked will be greater than the profit if successful. While most ITM’s will expire profitably, traders must always consider risk management with these positions and prepare in the event that one expires unsuccessfully.

Let’s look at an example of an ITM on the US 500. Looking at the table below, we can see all the daily ITM option strikes offered on this instrument.  For the purpose of this example, we will choose the 2154.0.Understanding ITM Options – Part 1With the underlying future trading at 2166.75, you could buy this option on the ask at 92.00. The strike is ITM because it is 12.75 points below the current futures price, allowing considerable room for price Understanding ITM Options – Part 1movement in a single day. This option expires at today’s 4:15 EST close, and its base value is $100. Please keep in mind that this is an illustration of an ITM option and is not intended to be a trade recommendation.

The risk on this option would be the $92.00 paid, while the potential reward would be the difference between the purchase price and the $100 value ($100 – $92), or a profit of $8.00 in this case, which is just less than a 10% return on risk.

The benefit of this option is the room it gives you to be correct; and if you have a strong conviction in your trade then you may not have to monitor it constantly, as this option’s price isn’t likely to fluctuate on every tick of the underlying futures. On the other hand, the drawback is the lower amount of reward on higher cost.

ITM options can be very successful when traded within responsible parameters. In follow-up articles next week, we will examine some of the risk management factors, as well as trade strategies and criteria, that go into selecting an ITM binary option.

Note: Exchange fees not included in calculations.

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