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.
| 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)
| 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 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.
| 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 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 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
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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 |
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