The Role of Strike Price in Binary Option Valuation

The Role of Strike Price in Binary Option Valuation

The binary option is a financial derivative contract where the payoff is either a fixed amount or nothing at all, depending on whether a specified condition is met by the expiry time. Central to understanding how this condition is determined is the concept of the **Strike Price**. For a beginner, grasping the role of the strike price is fundamental to making informed decisions when trading Call options or Put options.

What is the Strike Price?

In the context of a binary option, the strike price (also known as the exercise price or trigger price) is the predetermined level for the underlying asset's price at the moment the option is purchased. This price acts as the benchmark against which the actual price of the asset is measured when the option expires.

The strike price is fixed when you enter the trade and does not change throughout the life of the contract. It is the critical determinant of whether your option finishes In-the-money (a win) or Out-of-the-money (a loss of the initial investment).

Strike Price vs. Current Market Price

When you look at a trading screen on a platform like IQ Option or Pocket Option, you will see the current market price of the underlying asset (e.g., EUR/USD, Gold, or a stock index). When you decide to buy a binary option, you must choose a strike price relative to this current market price.

The relationship between the current market price and the chosen strike price dictates the type of binary option you are purchasing:

• For a Call option, you are betting the asset price will be *above* the strike price at expiration.
• For a Put option, you are betting the asset price will be *below* the strike price at expiration.

This distinction is crucial because, unlike traditional options where the strike price affects the premium paid, in most standard fixed-payout binary options, the strike price primarily affects the *probability* of winning, which is reflected in the offered Payout.

How Strike Price Influences Payout and Risk

In binary options, the broker or platform sets the strike price for various available contracts. These contracts are often grouped based on how far the strike price is from the current market price. This distance is often referred to as the "moneyness" of the option.

At-the-Money (ATM)

An ATM binary option has a strike price that is exactly equal to the current market price of the underlying asset when the trade is placed.

• If you buy a Call option ATM, the price needs to move up by even the smallest fraction above the strike price by expiry to win.
• If you buy a Put option ATM, the price needs to move down by even the smallest fraction below the strike price by expiry to win.
• ATM options typically offer a moderate payout percentage, reflecting a near 50/50 probability of winning (though the payout structure usually means a slight edge remains with the broker).

In-the-Money (ITM) (for entry)

In some systems, an ITM option refers to a contract where the strike price is already favorable to your predicted direction at the time of purchase.

• If you are buying a Call option, an ITM strike price would be *below* the current market price.
• If you are buying a Put option, an ITM strike price would be *above* the current market price.
• Because the asset price already meets or exceeds the winning condition at entry, these options offer lower payouts (sometimes as low as 50% or less of the investment) because the probability of success is very high. These are sometimes referred to as "high-probability" or "low-risk" trades by brokers, though this framing requires careful attention to Risk management.

Out-of-the-Money (OTM) (for entry)

An OTM binary option has a strike price that is currently against your predicted direction.

• If you are buying a Call option, an OTM strike price would be *above* the current market price.
• If you are buying a Put option, an OTM strike price would be *below* the current market price.
• OTM options require a larger move in the market price to reach the strike price by expiration. Consequently, they offer significantly higher payouts (sometimes 100% or more return on investment) because the perceived risk of the trade is higher.

The fundamental trade-off is clear: Higher potential Payout for OTM options requires a larger market move, while lower payouts for ITM options require only a minimal market move. Understanding this relationship is key to Understanding the Binary Options Payout Structure.

Strike Price Selection in Practice

Selecting the right strike price is intrinsically linked to your analysis of the market, your chosen Expiry time, and your overall Position sizing strategy. You are essentially selecting the hurdle the market must clear within the time limit you set.

1. Step-by-Step Guide to Strike Price Selection

This process assumes you have already analyzed the market using technical tools like RSI, MACD, or Support and resistance levels, and have determined a likely direction and timeframe for the move.

1. **Determine Direction and Asset:** Decide whether you will place a Call (up) or a Put (down) trade on a specific asset (e.g., EUR/USD).
2. **Select Expiry Time:** Choose an appropriate Expiry time. A shorter expiry (e.g., 60 seconds) requires a very small move, while a longer expiry (e.g., 30 minutes) allows for a larger move.
3. **Analyze Current Price:** Note the current market price (Spot Price).
4. **Identify Potential Target/Reversal Levels:** Based on your technical analysis (e.g., identifying the next major Support and resistance area or a Trend line), determine the price level you expect the market to reach or respect by the expiry time.
5. **Match Analysis to Strike Price Options:** Review the available strike prices offered by your broker for that asset and expiry.

   *   If your analysis suggests a strong, fast move past a minor hurdle, you might choose an OTM strike for a higher payout.
   *   If your analysis suggests the price will barely move past the current level, you might choose an ATM or slightly ITM strike for a safer, lower payout.

1. **Validate Against Volatility:** Consider the current market volatility. High volatility might make a slightly OTM strike achievable, whereas low volatility might require selecting an ATM strike to ensure the price moves enough.
2. **Execute the Trade:** Select the option (Call or Put) corresponding to your chosen strike price and confirm the investment amount, adhering strictly to your Risk management plan.

1. Example of Strike Price Selection

Imagine the EUR/USD spot price is currently 1.08500. You are looking at a 5-minute expiry. You believe the price will move slightly higher due to a recent positive news event.

Option Type	Target Strike Price	Rationale	Expected Payout
Call	1.08500 (ATM)	Requires minimal upward movement. Moderate risk/reward.	75%
Call	1.08515 (OTM)	Requires a slightly stronger move. Higher risk, higher reward.	90%
Call	1.08490 (ITM)	Price is already above the strike. Very low risk, very low reward.	55%

If you choose the 1.08515 strike price, you are betting that in 5 minutes, the EUR/USD price must be above 1.08515 to win the 90% payout. If the price is 1.08514 at expiration, you lose your investment.

Strike Price and Technical Analysis Integration

The strike price is not chosen in a vacuum; it must align with the signals generated by your chosen analysis methods.

1. Using Support and Resistance (S/R)

When trading based on Support and resistance, the strike price should ideally align with these established levels.

• **Breakout Strategy:** If you anticipate a strong move breaking through a known resistance level (e.g., at 1.1000), you would set your Call option strike price *just above* that level (e.g., 1.1005) for a slightly OTM trade, expecting the momentum to carry it further.
• **Reversal Strategy:** If you anticipate the price hitting a strong support level (e.g., at 1.0700) and bouncing back up, you would place a Call option. If the current price is 1.0710, you might choose an ATM strike of 1.0710, betting that the support will hold and the price will remain above it.

1. Using Indicators (RSI, MACD)

Indicators help gauge momentum, which informs how far you expect the price to move to reach your strike price.

• If the RSI shows extreme overbought conditions, suggesting a reversal is imminent, you would favor placing a Put option. You would select a strike price slightly above the current price (OTM Put) to capture the expected downward move.
• If the MACD crossover indicates a strong new Trend beginning, you might be more aggressive and select a strike price further away from the current price (more OTM) to maximize the Payout.

1. Candlestick Patterns and Strike Selection

Candlestick pattern analysis provides short-term confirmation of price action, which is vital for short-expiry binary options.

• If you observe a strong reversal Candlestick pattern (like a Hammer or Engulfing pattern) forming right at a key level, confirming your directional bias, you should select a strike price that requires only a minimal move in that direction (ATM or slightly ITM), as the pattern suggests immediate price movement.

Setting Realistic Expectations and Risks Related to Strike Price

The biggest mistake beginners make regarding the strike price is confusing high potential payout with high probability.

1. The Illusion of High Payouts

A 100% or 200% payout on an OTM trade sounds highly attractive. However, this high reward is offered because the probability of failure is significantly higher. If a broker offers an 85% payout on an ATM trade (50% probability), they are offering a fair-ish proposition. If they offer a 150% payout on a very OTM trade, they are signaling that the market likely needs to move significantly against the current price action to hit that strike, making it a low-probability event.

Realistic expectation means accepting that aiming for the highest payout strikes frequently will likely lead to rapid depletion of capital due to the difficulty of achieving large market moves within short Expiry time frames.

1. Risk Management and Strike Price

Your Risk management strategy must dictate your strike price selection, not the potential payout.

1. **Capital Allocation:** Never risk a large portion of your capital on a single trade, regardless of how favorable the strike price seems. Follow strict Position sizing rules.
2. **Strike Price Distance:** For beginners, focusing on ATM or slightly OTM strikes is generally safer than chasing very distant OTM strikes, even if the payout is lower. This ensures that minor market fluctuations align with your prediction, rather than requiring major, sustained directional moves.
3. **Avoiding "Lottery Tickets":** Trades where the strike price is extremely far from the current price (e.g., expecting a major stock index to move 500 points in 5 minutes) are speculative bets, not calculated trades. These should be avoided as they fall outside sound trading principles, similar to how one might evaluate speculative assets discussed in Starting Your Journey in Binary Options: Key Concepts Every New Trader Should Master.

1. The Impact of Expiry Time on Strike Price Viability

The chosen strike price is only relevant for the duration of the contract. A strike price that looks achievable at the start of a 30-minute trade might be impossible to reach if the Expiry time is only 60 seconds.

When using short expiries, the strike price must be very close to the current price (ATM or slightly ITM) because the market has very little time to move significantly. When using longer expiries (e.g., end-of-day), you can afford to choose a strike price further away (OTM) because you anticipate a larger overall market move during that period.

Practical Backtesting Idea Focused on Strike Distance

To understand the impact of the strike price distance, you should conduct simple backtesting using a Trading journal. This helps you move beyond theoretical understanding and see real-world results.

1. **Data Collection:** Use historical price data (or replay trades on a demo account, such as on IQ Option) for a specific asset (e.g., Gold).
2. **Fix Parameters:** Set a fixed Expiry time (e.g., 15 minutes) and a fixed analysis method (e.g., only trade when the price crosses the 20-period Bollinger Bands lower line, signaling a potential bounce).
3. **Test Three Scenarios:** For every qualifying signal, place three separate trades, varying only the strike price distance:

   *   Trade A: ATM Strike Price.
   *   Trade B: Strike Price 5 pips/points away (Slightly OTM).
   *   Trade C: Strike Price 15 pips/points away (Significantly OTM).

1. **Record Results:** Log whether each trade was ITM or OTM at expiration, the payout received, and the net profit/loss.
2. **Analyze:** After 50 iterations, analyze which strike distance provided the best risk-adjusted return. You will likely find that the slightly OTM trades (Trade B) offer the best balance, while the significantly OTM trades (Trade C) often result in heavy losses despite high potential payouts.

This exercise directly teaches you how the strike price distance interacts with market reality for your chosen timeframe, a concept that experienced traders continuously refine, as noted in How Can Experienced Traders Adapt to Changing Market Trends in Binary Options?.

Common Mistakes Regarding Strike Price

Beginners often make predictable errors when selecting the strike price, which directly undermines their Risk management.

• **Chasing High Payouts:** Selecting strikes that require massive moves simply because the payout is high. This ignores the underlying probability structure.
• **Ignoring Volatility:** Placing an OTM trade during a low-volatility period. The market lacks the energy to reach the required strike price.
• **Inconsistent Application:** Switching randomly between ATM, ITM, and OTM strikes without a defined strategy or understanding of what each choice implies for the expected return versus required price movement. If you are using complex analysis like Elliott wave theory, your strike selection must reflect the expected magnitude of the next wave.
• **Misunderstanding ITM Entry:** Confusing an ITM trade (which is already winning) with an OTM trade (which requires a favorable move). Always confirm the strike price relative to the current price *before* clicking 'Buy'.

Conclusion: The Strike Price as a Risk Lever

The strike price is the single most important variable you control (alongside the Expiry time) when entering a binary option trade, as it directly sets the hurdle for success. It is the lever you pull to balance risk against reward. A strike price too far away from the current price increases your potential reward but drastically lowers your probability of success, turning the trade into a speculative gamble rather than a calculated entry. Successful trading in this environment, whether on IQ Option or any other platform, requires using technical analysis to predict where the price *will be*, and then selecting a strike price that offers a realistic probability of that level being breached or respected by the contract's end. You must internalize this relationship before attempting to Apply the Learned Strategies.

Component	Primary Function in BO Valuation	Beginner Focus
Strike Price	Sets the threshold for ITM/OTM determination	Balancing payout vs. required market move.
Current Price	The starting point for measurement	Confirming the relationship (ATM, ITM, OTM) at entry.
Expiry Time	Defines the duration the price must remain above/below the strike	Must match the expected speed of the predicted move.

Recommended Binary Options Platforms

Platform	Why beginners choose it	Register / Offer
IQ Option	Simple interface, popular asset list, quick order entry	IQ Option Registration
Pocket Option	Fast execution, tournaments, multiple expiration choices	Pocket Option Registration

Join Our Community

Subscribe to our Telegram channel @copytradingall for analytics, free signals, and much more!