View source for Calculating Potential Profit or Loss on an Expired Option

= Calculating Potential Profit or Loss on an Expired Option =

This article focuses exclusively on determining the outcome—the profit or loss—of a [[Binary option]] contract once its [[Expiry time]] has been reached. Understanding this calculation is the fundamental closing step of any trade, regardless of whether you used a [[Call option]] or a [[Put option]].

== The Core Concept of Binary Option Expiration ==

A [[Binary option]] is a financial derivative where the payoff is either a fixed amount of money or nothing at all. Unlike traditional options, you do not buy or sell an underlying asset; you are simply betting on the direction of the price movement over a set period. The entire profit or loss calculation hinges on one single factor: the position of the asset's price relative to the strike price at the exact moment of expiration.

The relationship between the asset price at expiry and the entry price determines whether the option finishes [[In-the-money]] (ITM) or [[Out-of-the-money]] (OTM).

=== Defining In-the-Money (ITM) ===

An option finishes ITM when the outcome matches the prediction made at the time of entry.

*   For a [[Call option]] (prediction: price goes up), the final price must be strictly higher than the strike price.
*   For a [[Put option]] (prediction: price goes down), the final price must be strictly lower than the strike price.

When an option expires ITM, the trader receives their initial investment back, plus the predetermined [[Payout]].

=== Defining Out-of-the-Money (OTM) ===

An option finishes OTM when the outcome does not match the prediction made at the time of entry.

*   For a [[Call option]], the final price is equal to or lower than the strike price.
*   For a [[Put option]], the final price is equal to or higher than the strike price.

When an option expires OTM, the trader loses the entire amount invested in that specific trade. This total loss of capital is the maximum risk associated with any single [[Binary option]] trade, which is a key aspect of [[Risk management]].

=== The Break-Even Point: At-the-Money (ATM) ===

If the asset price is exactly equal to the strike price at the moment of expiration, the option is considered At-the-Money (ATM). In nearly all standard binary option contracts, an ATM expiration results in the loss of the initial investment, treating it the same as an OTM outcome.

== Calculating Profit: The ITM Scenario ==

When a trade is successful (ITM), the calculation for the total return is straightforward. The profit is calculated based on the defined [[Payout]] percentage offered by the broker for that specific asset and [[Expiry time]].

The formula for calculating the total return when ITM is:

Total Return = Investment Amount + (Investment Amount * Payout Percentage)

The net profit is simply the second part of that equation:

Net Profit = Investment Amount * Payout Percentage

It is crucial to note that the Payout Percentage is always quoted relative to the initial investment, not the total account equity.

=== Example Calculation (Call Option) ===

Assume a trader buys a 5-minute [[Call option]] on EUR/USD with the following parameters:

*   Investment Amount: $100
*   Broker Payout Percentage: 85%
*   Strike Price: 1.10000
*   Expiry Time: 5 minutes later

Scenario A: Successful Expiry (ITM)
If the price at expiry is 1.10005 (higher than the strike), the option is ITM.

Net Profit = $100 * 0.85 = $85.00
Total Return = $100 (Investment) + $85.00 (Profit) = $185.00

This calculation confirms that the trader receives their original $100 stake back, plus $85 in profit.

{| class="wikitable"
! Component !! Value !! Result
|-
| Investment || $100 ||
|-
| Payout Rate || 85% ||
|-
| Net Profit || $100 * 0.85 || $85.00
|-
| Total Received || $100 + $85.00 || $185.00
|}

== Calculating Loss: The OTM or ATM Scenario ==

If the trade is unsuccessful (OTM) or lands exactly on the strike price (ATM), the outcome is the loss of the entire capital risked on that single trade.

The formula for calculating the loss is:

Net Loss = Investment Amount

This highlights the fixed-risk nature of binary options. Unlike futures or stock options, where losses can potentially exceed the initial investment (though not typically in standard retail accounts), the maximum loss in a binary option is strictly limited to the amount paid to open the contract. This concept is central to [[Setting Appropriate Position Size Relative to Account Equity]].

=== Example Calculation (Put Option) ===

Assume a trader buys a 10-minute [[Put option]] on Gold with the following parameters:

*   Investment Amount: $50
*   Broker Payout Percentage: 80%
*   Strike Price: $2300.00
*   Expiry Time: 10 minutes later

Scenario B: Unsuccessful Expiry (OTM)
If the price at expiry is $2300.05 (higher than the strike), the option is OTM because the prediction was that the price would fall.

Net Loss = $50.00
Total Return = $0.00 (The initial $50 is forfeited)

{| class="wikitable"
! Component !! Value !! Result
|-
| Investment || $50 ||
|-
| Payout Rate || 80% ||
|-
| Net Loss || Full Investment || $50.00
|-
| Total Received || Investment Returned (0) || $0.00
|}

== Practical Steps for Entry, Exit, and Verification ==

While the calculation happens automatically upon expiration, successful traders must follow a structured process to ensure they are entering trades correctly and verifying the results accurately. This process involves setting up the trade based on analysis and then verifying the final price against the entry price.

=== Step 1: Analysis and Setup (Entry Preparation) ===

Before placing the trade, the trader uses technical analysis tools, such as charting indicators like the [[RSI]], [[MACD]], or patterns derived from [[Candlestick pattern]] analysis, often in conjunction with identifying [[Support and resistance]] levels or assessing the overall [[Trend]].

*   Determine the required direction (Call or Put).
*   Select the appropriate [[Expiry time]] that aligns with the expected duration of the price move.
*   Identify the exact strike price (which is usually the current market price when the order is placed, though some platforms allow setting the strike price slightly away from the current market).
*   Determine the [[Position sizing]] (Investment Amount) based on [[Risk management]] rules.

=== Step 2: Order Execution ===

The trade is placed on the platform (e.g., [[IQ Option]] or [[Pocket Option]]). The platform locks in the strike price and the expiry time. The investment amount is immediately deducted from the available balance.

=== Step 3: Monitoring and Waiting ===

The trader monitors the live chart for the duration of the contract. For short-term options (e.g., 60 seconds), monitoring is intense. For longer options, the trader might analyze other factors, such as potential shifts in market sentiment or major news events that could invalidate their initial analysis (e.g., if an [[Elliott wave]] count seems to be failing).

=== Step 4: Expiration and Automatic Settlement ===

When the [[Expiry time]] is reached, the broker's server automatically compares the final price tick against the strike price.

*   If ITM, the profit is credited instantly to the account balance.
*   If OTM/ATM, the investment is removed from the balance.

=== Step 5: Verification and Journaling (Essential for Improvement) ===

This step is often overlooked by beginners but is vital for long-term success and adhering to [[The Role of Emotional Control in Consistent Trading]].

*   Record the entry price, strike price, expiry time, investment, payout rate, and the final closing price in a [[Trading journal]].
*   Calculate the actual net profit or loss manually to confirm the broker's settlement.
*   Note the reason for the trade (e.g., "Bounced off 1.1000 support confirmed by [[Bollinger Bands]] crossover").

If the result does not match the expected outcome based on the final price tick, the trader should immediately check the broker’s recorded execution data.

== Setting Realistic Expectations and Risks ==

The calculation of profit or loss is simple, but the reality of consistent profitability requires managing expectations around the payout structure and the inherent risk.

=== The Impact of the Payout Percentage ===

The Payout Percentage (e.g., 70% to 95%) directly dictates the required win rate needed to break even over time. Since the maximum loss is 100% of the investment, but the maximum gain is less than 100% of the investment, a trader must win more often than they lose just to cover the losses from OTM trades.

Consider a scenario where the average payout is 80%. If a trader risks $100 per trade:

*   Win ($100 investment + $80 profit) = $180 return
*   Loss ($100 investment) = $0 return

To break even over 10 trades, the trader needs 6 wins and 4 losses:

*   6 Wins: 6 * $80 profit = $480
*   4 Losses: 4 * $100 loss = -$400
*   Net Result: +$80 profit

If the win rate drops to 5 wins and 5 losses:

*   5 Wins: 5 * $80 profit = $400
*   5 Losses: 5 * $100 loss = -$500
*   Net Result: -$100 loss

This illustrates that even small variations in win rate significantly impact the final outcome, emphasizing the importance of high-quality setups supported by robust technical analysis, such as confirming signals across multiple indicators or respecting clear [[Support and resistance]] zones. You can read more about developing profitable methods at [https://binaryoption.wiki/index.php?title=Unlocking_Passive_Income_Potential%3A_A_Beginner%27s_Guide_to_Binary_Options_Trading_Success Unlocking Passive Income Potential: A Beginner's Guide to Binary Options Trading Success].

=== Understanding Fixed Risk vs. Variable Reward ===

The primary risk management feature in binary options is the fixed loss. You will never lose more than your stake. However, the variable reward means that even when you are right, the return is capped. This contrasts sharply with asset trading where a successful trade can yield unlimited profit potential, although the potential loss is also unlimited (unless stop-losses are used). For example, trading a [[Call option]] on a major stock index might offer a potentially unlimited upside if you were using traditional options, but with a binary option, the profit is strictly limited by the broker's stated payout for that contract.

== Simple Backtesting Idea for Expiry Outcomes ==

To build confidence in a strategy before risking real capital, backtesting the expiry outcome is essential. Since the calculation relies only on the price at the strike versus the price at expiry, you can test historical data easily.

# Select a historical chart (e.g., 1-minute chart for 5-minute options).
# Identify a point where you would have entered a trade based on your chosen criteria (e.g., a strong [[Trend]] reversal signal using [[MACD]]). Note the exact time and price (Strike Price).
# Look exactly 5 minutes ahead on the chart. Note the closing price of that 5th minute candle (Expiry Price).
# Determine if the Expiry Price was ITM or OTM based on your entry direction.
# Assume a standard 85% payout for ITM trades and 0% for OTM trades.
# Record the result in your [[Trading journal]].

Repeat this process for at least 50 to 100 historical instances to gauge the theoretical win rate and expected profitability.

{| class="wikitable"
! Trade # !! Entry Time !! Strike Price !! Expiry Time !! Final Price !! Outcome (ITM/OTM) !! Payout ($100 Risk)
|-
| 1 || 10:00:00 || 1.10000 || 10:05:00 || 1.10015 || ITM || +$85.00
|-
| 2 || 10:01:00 || 1.10005 || 10:06:00 || 1.10005 || ATM (Loss) || -$100.00
|-
| 3 || 10:02:00 || 1.09990 || 10:07:00 || 1.09988 || ITM || +$85.00
|}

== Common Mistakes Related to Expiry Calculation ==

Beginners often miscalculate or misunderstand the final settlement due to a few common errors:

*   Mistake 1: Assuming the price must move significantly. Because the payout is fixed, a move of just one pip above the strike price results in the same profit as a massive move. Over-leveraging based on a large expected move is poor [[Position sizing]].
*   Mistake 2: Ignoring the exact tick time. If a trade is set for 5 minutes, and the price moves in your favor at 4 minutes and 59 seconds, but reverses sharply in the final second to cross the strike price, the trade will be OTM. The final tick matters, not the peak movement during the trade duration.
*   Mistake 3: Confusing Payout with Profit. Traders sometimes think an 85% payout means they profit 85% of their account equity. It means they gain 85% of their *investment* stake.
*   Mistake 4: Not tracking the closing price source. Different brokers might use slightly different price feeds for settlement, which can cause minor discrepancies if you are trying to verify the result against a public chart feed. Always rely on the broker's recorded settlement price for official results. For more advanced platform workflows, see documentation on [https://binaryoption.wiki/index.php?title=Ouvrir_un_compte_sur_Pocket_Option Ouvrir un compte sur Pocket Option].

The final profit or loss calculation is the definitive result of the [[Binary option]] contract, determining the success or failure of the prediction made at the time of entry. Mastering this simple arithmetic, coupled with disciplined execution based on sound analysis, is the foundation of trading these instruments. For those interested in exploring account management specifics, reviewing guides on platforms like [https://binaryoption.wiki/index.php?title=IQ_Option IQ Option] can provide context on where these settlements appear in your balance history.

== See also (on this site) ==
* [[Defining the Core Concept of a Binary Option Contract]]
* [[How Brokers Present Available Tradable Assets]]
* [[Setting Appropriate Position Size Relative to Account Equity]]
* [[The Role of Emotional Control in Consistent Trading]]

== Recommended articles ==
* [https://binaryoption.wiki/index.php?title=Binary_Option_Signal_Strategies Binary Option Signal Strategies]
* [https://binaryoption.wiki/index.php?title=Trailing_stop-loss_orders Trailing stop-loss orders]
* [https://binaryoption.wiki/index.php?title=Domina_los_Conceptos_B%C3%A1sicos_de_Pocket_Option%3A_Estrategias_Sencillas_para_Invertir_en_Opciones_Binarias Domina los Conceptos Básicos de Pocket Option: Estrategias Sencillas para Invertir en Opciones Binarias]
* [https://binaryoption.wiki/index.php?title=Option_Trading_Techniques Option Trading Techniques]
* [https://binaryoption.wiki/index.php?title=Binary_Option_Traders Binary Option Traders]

== Recommended Binary Options Platforms ==
{| class="wikitable"
! Platform !! Why beginners choose it !! Register / Offer
|-
| IQ Option || Simple interface, popular asset list, quick order entry || [https://affiliate.iqbroker.com/redir/?aff=1085&instrument=options_WIKI IQ Option Registration]
|-
| Pocket Option || Fast execution, tournaments, multiple expiration choices || [http://redir.forex.pm/pocketo Pocket Option Registration]
|}
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[[Category:Binary Options Basics]]