Binary Options Strike Price and Underlying Price

By | February 24, 2016

Binary option strike price and underlying priceIt is important to explain some basic terms that are related to binary options strike price and underlying price:

  • At-the-money (ATM) – this term is used to describe situation where strike price and the underlying market price are the same
  • In-the-money (ITM) – this is situation where the underlying market price is greater than the strike price
  • Out-of the-money (OTM) – opposite of in-the-money, out-of-the-money means that underlying price is smaller than the strike price
  • Deep-out-of-the-money & Deep-in-the-money – these are the outer strike price ladders. A way to define the deepness from a price point of view is when the spot price is a 10% probability for out-of-the-money and 90% in-the-money
  • Near-the-money – this term is closely related to at-the-money term. Near-the-money means that the strike price is approximately at-the-money.

Strike price vs. underlying price

That explained we can move on to strike price vs. underlying market price. Strike price is fixed price of underlying asset. Every option has defined strike price. In binary options trading you are basically choosing whether price of underlying asset will be below or above strike price upon options expiration.  E.g. if trader buys a call option for stock A with the strike price of 50 dollars, this means that if upon binary options expiration market price is above strike price binary option expires in-the-money. In the opposite case it is out-of-the money. Strike price is defined for every option and always in advance, it can’t be changed once option is purchased.

Unlike strike price, binary options underlying market price changes during option’s lifetime. This is due the fact that price of the underlying asset is decided on the market and dictated by supply and demand.  It is market price of stock A from example above. But the market price of underlying (stock A) directly implies the intrinsic value of the binary option through its relationship with the option’s fixed strike price.

Summary

Binary options strike price is fixed, while price of underlying asset is constantly fluctuating according to forces of supply and demand. It is important to know that strike price is influenced by price of the underlying asset, it is actually formed by brokers views on how will market price of underlying asset move over certain period. Always remember that options are derivative securities and by definition the price of derivative security is derived from the price of its underlying asset. The extent to which an options market price depends on the market price of its underlying is measured by some of the well known Greek letters, namely delta and gamma (more about them in another article).