Understanding the Value of Time with Binary Options

Understanding the Value of Time with Binary Options
Understanding the Value of Time with Binary Options
Understanding the Value of Time with Binary Options Getty Images

In trading, timing is everything. We all know that time does not stand still. It has been said, “Time is the most important commodity.” There is another saying that basically goes like this: “If you’re early, you’re wrong.” This humbling reality is something that all traders have had to learn. Many traders have likely read books or seen movies depicting financial institutions that traded against housing before the 2007 credit crash. Some of these institutions nearly went insolvent positioning against the market too soon. We all know what it means to have a strong idea, to trade it, and then to be stopped out of the market shortly before the market ends up doing nearly exactly what we expected.

When trading any option, time becomes an even more relevant factor because options all have a time expiration. In fact, part of the value of any option is time, or theta.  The further away an option is from expiration, the greater the possibility that anything can happen, and there is a time value written into that option.

However, as that option nears expiration, the clock is running out; therefore, the possibilities grow smaller, and the value, especially for an out-of-the-money option, will grow weaker – most certainly if the price movement has not compensated for the time decay.

Understanding the Value of Time with Binary Options

How many times have you traded a binary option, only to have moments after expiration be the difference between a profitable trade and a losing trade, and you end up feeling like you just ran out of time?  This will happen to any trader at times; but we can all make sure that we are as educated and prepared as possible.

The binary option tables pictured both show the EUR/USD currency pair; and both sets of options on each table expire today. One set of options expires at 8:00 am while the other set expire at 3:00 pm, a seven hour difference.

Understanding the Value of Time with Binary Options

While the tables do not share the same strikes, you can make a general comparison and see the difference in the time value of the longer duration options compared to the closer expiry.

Specifically, note that each expiry has an option offered at just over $8.00. However, for the 8:00 a.m. expiry, the $8.00 option is the 1.0698; but for the 3:00, the same priced option is the 1.0740 strike, a difference in 42 pips.

Doing a price comparison gives a good idea of how time will affect these options. The main thing is for traders to be aware of time value, and in some cases to be able to adapt their strategies based on this understanding.

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