Understanding the Role of the Strike Price in Binary Options
Understanding the Role of the Strike Price in Binary Options
The Binary option is a financial derivative where the payoff is fixed and determined entirely by whether a specific condition is met before a set Expiry time. Central to understanding how a binary option trade resolves is the concept of the Strike Price. For absolute beginners, grasping the strike price is the first step toward making informed trading decisions, whether you are considering a Call option (betting the price will go up) or a Put option (betting the price will go down).
What is the Strike Price?
The Strike Price, sometimes called the Exercise Price, is the predetermined level or price point at which the underlying asset (such as a currency pair, stock index, or commodity) must be trading at the moment of expiration for the option to result in a profit.
In essence, the strike price acts as the dividing line between winning and losing for the trader.
Definition in Context
In the context of binary options, the strike price is fixed when the trade is initiated. Unlike traditional options, where the strike price determines the right to buy or sell, in binary options, the strike price determines the outcome:
- If you buy a Call option, you win if the asset's final price is strictly *above* the strike price at expiration.
- If you buy a Put option, you win if the asset's final price is strictly *below* the strike price at expiration.
The relationship between the current market price and the strike price at the moment of entry determines whether the option is currently In-the-money or Out-of-the-money.
Strike Price vs. Current Market Price
When you look at a trading screen on platforms like IQ Option or Pocket Option, you will see the current market price fluctuating in real-time. The strike price, however, is static for your specific trade.
For example, if the EUR/USD currency pair is currently trading at 1.10500, and you decide to place a 5-minute Call option with a strike price set at 1.10510, you are betting that in five minutes, the price will be higher than 1.10510. The 1.10500 is the entry price, but 1.10510 is the critical level—the strike price—that determines your win or loss.
How Brokers Present the Strike Price
Binary options brokers often simplify the selection process compared to traditional markets. Instead of complex option chains, the available strike prices are usually presented directly on the trading interface, often tied to the available Expiry time slots.
Selection Mechanisms
The method for selecting the strike price depends heavily on the broker's interface and the asset being traded.
- Fixed Strike Selection: For very short-term options (like 60-second trades), the strike price is often automatically set to the current market price at the exact moment the trade is executed. The trader is simply betting on the direction in the next moment.
- Predefined Strike Selection: For longer expiries (e.g., 1 hour, End-of-Day), the platform will offer a limited menu of strike prices relative to the current market price. You select the strike that offers the best perceived risk/reward ratio based on your analysis.
Strike Price and Payout Relationship
There is a direct, albeit sometimes subtle, relationship between the strike price chosen and the potential Payout. This relationship is crucial for understanding the Defining the Binary Options Payout Structure.
- Closer Strike: If the chosen strike price is very close to the current market price (e.g., only 1 pip away), the trade is inherently riskier because the market has less distance to move in your favor. Brokers often offer a slightly higher Payout percentage for these "at-the-money" or "near-the-money" trades, though this varies widely.
- Further Strike: If the chosen strike price is far away from the current market price (e.g., 50 pips away), the trade requires a significant market move. These trades might sometimes offer a slightly lower payout because the probability of reaching that distant level within the timeframe might be perceived as lower by the broker's internal algorithm, or conversely, they might offer a higher payout due to the increased difficulty.
| Scenario | Current Price (EUR/USD) | Chosen Strike Price | Option Type | Outcome if Price at Expiry is 1.10550 |
|---|---|---|---|---|
| A (Near) | 1.10500 | 1.10510 | Call | Win (In-the-money) |
| B (Far) | 1.10500 | 1.10650 | Call | Loss (Out-of-the-money) |
| C (Near) | 1.10500 | 1.10490 | Put | Win (In-the-money) |
Determining the Optimal Strike Price: Analysis Techniques
Selecting the correct strike price requires anticipating where the market will be at the Expiry time. This anticipation is driven by market analysis, similar to how one analyzes for Comparing Binary Options to Traditional Forex Trading.
Using Technical Analysis to Set Strikes
Traders use various tools to predict price movement and thus select an appropriate strike price.
Support and Resistance Levels
Support and resistance levels are key price points where buying or selling pressure has historically been strong.
- For a Call Option: If the current price is consolidating just above a strong support level, a trader might set the strike price slightly above that support level, expecting the support to hold and the price to move up before expiry.
- For a Put Option: If the price is approaching a known resistance level from below, the trader might set the strike price just below that resistance, anticipating the rejection and subsequent fall.
Trend Following
When a strong Trend is established, the strike price selection should align with that momentum.
- If the market is in a strong uptrend, placing a Call option with a strike price slightly above the current price is common, betting the trend will continue to carry the price higher.
- If placing a Put option against a strong trend, the strike price must be set further away to account for the market's inertia, acknowledging the higher risk involved in counter-trend trading.
Indicator Confirmation
Indicators help confirm the conviction behind the chosen strike price.
- RSI: If the RSI is indicating an oversold condition (below 30) and you select a Call option, you would typically set the strike price near the current level, expecting a bounce. If the RSI is overbought (above 70) for a Put option, the strike price should be set near the current level, expecting a reversal.
- MACD: A bullish crossover on the MACD might encourage setting a strike price slightly above the current market price for a Call option.
Validation and Invalidation Rules for Strike Selection =
The choice of strike price is validated or invalidated by the market's behavior during the option's life.
- Validation: If you chose a strike price based on a Support and resistance level holding, and the price respects that level (e.g., bounces off support) immediately after your entry, the strike selection is validated.
- Invalidation: If the market price immediately breaches the level upon which your strike selection was based (e.g., breaks through support when you bought a Call option expecting support to hold), the trade setup is immediately invalidated, and you should prepare for a loss unless the broker offers early closing features.
A common mistake is setting the strike price too close to the entry price when using indicators that suggest a major reversal is imminent. If the RSI screams oversold, setting the strike price only 1 pip away might not give the market enough room to move before the Expiry time.
Step-by-Step: Executing a Trade Based on Strike Price
This sequence assumes you have already performed your market analysis (e.g., identified a Candlestick pattern or confirmed a Bollinger Bands reversal signal).
- Determine the Direction: Decide whether you need a Call option (up) or a Put option (down).
- Select the Asset and Expiry: Choose the underlying asset and the required Expiry time.
- Analyze Market Position: Note the current market price (e.g., 1.25000).
- Determine Strike Preference: Based on your analysis (e.g., expecting a bounce off support at 1.24950), decide where the price *must* be at expiration.
- Review Broker Offerings: Look at the available strike prices offered by your broker for that specific expiry.
- Select the Strike Price: Choose the strike price that aligns with your analysis. For a Put option expecting a drop from 1.25000, you might select a strike of 1.24980.
- Determine Investment Amount: Decide on your investment based on your Risk management plan and Position sizing rules. Remember that in binary options, the risk is limited to the premium paid.
- Review Payout: Confirm the resulting Payout percentage for the selected strike and investment amount.
- Execute the Trade: Click the Buy/Call or Sell/Put button to lock in the strike price and investment.
- Monitor Resolution: Watch the market price relative to your fixed strike price until the Expiry time is reached to see if the trade is In-the-money.
Realistic Expectations and Risk Management Related to the Strike Price
The strike price is inextricably linked to the risk profile of a binary option. Understanding this link is vital for sustainable trading, especially when considering The Impact of Emotional Bias on Trading Decisions.
The Binary Option Certainty
The primary difference between binary options and instruments like traditional Forex is the certainty of the outcome based on the strike price.
- In Forex, if the price moves slightly in your favor but not enough to cover the spread, you might break even or lose a tiny amount.
- In binary options, if the price is $0.00001 past the strike price in your favor at expiration, you receive the full Payout. If it is $0.00001 on the wrong side, you lose 100% of your investment for that specific trade.
This "all or nothing" nature, dictated by the strike price, demands strict adherence to Risk management.
Strike Price and Volatility
Market volatility significantly impacts strike price selection.
- High Volatility: During high volatility events (like major news releases), prices move rapidly. A trader might opt for a strike price that is further away from the current price, requiring a larger move, as the chance of a large swing occurring is higher. However, high volatility also increases the chance of sudden reversals that can push the price past your strike against your position.
- Low Volatility: In quiet markets, setting a strike price too far away is dangerous, as the market may lack the energy to reach it before expiry. Traders often select strikes very close to the current price, hoping for small, incremental movements.
If you are employing advanced concepts like Elliott wave theory, your strike price selection must align with the expected magnitude of the next wave segment.
The Importance of the Trading Journal
To improve strike selection, every trade must be recorded in a Trading journal. This journal should specifically track:
- The market price at entry.
- The chosen strike price.
- The reason for selecting that strike (e.g., "Betting on rejection at resistance R1").
- The final outcome relative to the strike price.
Reviewing this data helps identify if you consistently select strikes that are too aggressive (too close to the entry price) or too conservative (too far away for the given time frame). This empirical data is far more valuable than guesswork.
Practical Checklist for Strike Price Selection
Use this checklist before confirming any binary option trade:
- Have I confirmed the asset's current price?
- Have I chosen an Expiry time that allows my predicted move to materialize?
- Does my chosen strike price align with my primary analysis tool (e.g., is it above a confirmed Support and resistance level)?
- If I am trading against the immediate Trend, is my strike price set far enough away to absorb temporary pullbacks?
- Have I checked if the chosen strike price offers a reasonable Payout relative to the perceived difficulty of reaching it?
- Does my investment size comply with my Position sizing rules, given the fixed risk associated with this specific strike?
- If I were to use a technical tool like MACD for confirmation, does the indicator support the direction implied by my strike selection?
Simple Backtesting Idea for Strike Price Efficacy
Since you cannot change the strike price once the trade is placed, backtesting focuses on historical *decision-making* regarding strike selection.
- Select a historical asset and time frame (e.g., GBP/USD, 15-minute chart).
- Identify 20 instances where a clear signal occurred (e.g., a strong bullish Candlestick pattern).
- For each instance, determine the market price at the signal time.
- Hypothetically, choose a 10-minute Expiry time.
- Determine the optimal strike price you *would have* chosen based on your current strategy (e.g., 5 pips above resistance).
- Now, check the actual price 10 minutes later. Did the market price end up above your hypothetical strike price?
- Record the win/loss percentage based on your hypothetical strike selection.
This exercise helps build confidence in translating analysis into a concrete, measurable strike price target. While this is not the same as algorithmic execution—which can be explored further at How Can Algorithmic Trading Enhance Binary Options Strategies?—it reinforces the critical step of target setting. Remember that even the best analysis must be executed carefully, perhaps even using mobile tools, as discussed in Essential Tips for Trading Binary Options Successfully on Mobile Apps. When selecting a broker, always check their compliance status, for instance, by reviewing Choosing a binary options broker.
Conclusion
The Strike Price is the single most important determinant of success or failure in a Binary option. It is the objective benchmark against which your prediction is measured. A successful trader does not just predict direction; they predict direction *to a specific level* within a specific time frame. Mastering the art of selecting a strike price that balances achievable market movement with an acceptable Payout is fundamental to effective trading and sound Risk management.
See also (on this site)
- Defining the Binary Options Payout Structure
- Comparing Binary Options to Traditional Forex Trading
- Calculating Position Sizing for Fixed-risk Trades
- The Impact of Emotional Bias on Trading Decisions
Recommended articles
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- How Can Traders Effectively Minimize Losses in Binary Options?
- How Do International Regulations Impact Binary Options Markets?
- Binary Options Battery Optimization
- Binary options risk reversal
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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