Basics of Binary Option Trading

07/21/2011 7:00 am EST

Focus: OPTIONS

Binary options present unique trading opportunities, but understanding key variables like expiration, settlement, and strike price is critical to success. Start by reading this helpful resource.

When you trade binary options on a market, there is not just one variable for you to trade; there are several choices you need to make in terms of expiration times and strike prices on every market on the Nadex exchange. You’re never short of a unique trading opportunity in this “newer” security.

Binary options are available on stock index futures based on indices like the S&P 500, popular spot forex pairs such as EUR/USD, and commodity futures on energies, metals, and more. You can even trade economic events like the weekly jobless claims number using binary options.

See video: How Binary Options Limit Your Risk

Here’s how they work:

Expiration Times

Expiration times can be split into four categories:

  1. Intraday: At times within the current trading day
  2. Daily: At the end of the current trading day
  3. Weekly: At the end of the current trading week
  4. Event-based: At a specified time and date in the future 

Different expiration times give the trader the opportunity to trade on price movements over different time frames, ranging from the very short term to weeks ahead.

Expiration Value

When a contract expires, an expiration value is obtained by reference to the underlying market according to the following rules:

  1. Sample the last 25 trade or midpoint* prices in the underlying market
  2. Remove the highest five prices and the lowest five prices
  3. The expiration value is the arithmetic average of the remaining 15 prices rounded to one decimal point past the precision of the underlying market (with the exception of Wall Street 30, which is rounded to the same precision as the underlying market)

The market prices used by Nadex to calculate such expiration values are obtained through a data feed from Reuters. If Reuters is unavailable, Nadex may obtain market pricing data through Bloomberg or other data provider, as determined appropriate under the circumstances.

For contracts on economic events, the expiration value cannot be calculated as above; see Economic Events for more information.

*Midpoint prices apply to spot forex contracts; for more specific details, reference the individual contract in the Nadex rulebook.

Settlement: Binary Options

Binary options are cash-settled contracts with an all-or-nothing payout that allow trading on the expected direction of the underlying market.

The settlement value is obtained by comparison of the expiration value and the strike price with reference to the condition specified in the contract.

  1. Expiration value condition is achieved: Settlement value = 100
  2. Expiration value condition is not achieved: Settlement value = 0

Strike Prices

The strike price of a binary option is the level of the underlying market against which the option is settled. In a Gold >$950 at 1:30 pm contract, for example, the strike price is $950.

Nadex lists a range of strike prices for each expiration time of each underlying market. For example, Nadex lists 23 different strike prices for each daily gold expiration, all staggered at intervals of $3.

By the Staff at Nadex

Visit the Options Center to learn more about binary options

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