Know The Price You Are Paying

In Blog by Michael Arnold

In order to buy an option, you have to pay a premium or price for that option. When you can see the amount that will be debited from your account right on your order ticket (as you do when trading Nadex binary options or spreads), then you know what you are paying but do you truly know what goes into it?

People tend to think options are complicated and due to the simple yes or no characteristics of Nadex binary options, it is often forgotten that binary options are in fact options. The cost of an option (known as the premium) can change based on factors other than just movement of the underlying market. Becoming familiar with these other factors is the true way to know what you’re paying for an option.

It is possible for the premium of the exact same option, with the underlying market trading at the exact same price to be different only a few minutes later. Changes in volatility and time left to expiration can affect the value of a binary option with no movement in the underlying price at all. This means there are times when, even though your order ticket has your risk (or the price you are paying) listed right on it and it looks “cheap” you may be paying way too much based on where volatility is and how much time there is to expiration (the effect that time has on an option  is known as “theta”). It is not smart to buy an option during high a volatility period with 3 hours left to expiration and market movement expected to slow down during that time. That trade is expensive, regardless of what the price on your order ticket says, because you are overpaying for the probability of the binary option going in the money.  Knowing the true price you are paying by understanding volatility and theta, as well as all the other option “greeks” changes the risk profile of any trader for the better.

Futures, options and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results