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Definitions of ITM, ATM and OTM
This is the short definition of these phrases and what they mean. To trade binary option contracts successfully, you need to understand each of these descriptions, what they mean in practice, and the various potential outcomes when you place an order. This article will help you to understand the significance of a contract being ITM, ATM, and OTM, so you can make more informed trading decisions.
Talking points:
What is in-the-money?
What is at-the-money?
What is out-of-the-money?
ITM, ATM, and OTM binary option examples
What is in-the-money (ITM)?
A binary option contract is in-the-money when the indicative market is above the strike by at least one tick or point.
If you are buying binary option contracts, those that are ITM have the highest chance of making you a profit. This is because there are three ways to profit:
The indicative price keeps moving up.
The market stays flat.
The indicative price moves down but stays above the strike.
The main limitation when buying ITM binary option contracts is the higher bid/offer price. This is the case because the contract is already in-the-money and your chance of profiting is higher.
You will have a lower profit potential due to this higher bid/offer price. The profit for binary option contracts is always calculated out of $100, so if you have paid more for the contract, your profit potential will be lower. For example, if you pay $70 for an ITM contract, your profit potential is $30 ($100 - $70). If you only pay $30 for the contract, your profit potential is $70. Profit potential is calculated excluding fees.
Below is an example of an ITM order ticket. As you can see, the strike price is 1734.5 and the underlying market is at 1743.907, which is higher than the strike price. The bid/offer prices are above the $50 mark, limiting your potential profit if you were to buy this contract. However, if you believe this market is going to revert back, passing the strike level of 1734.5, you may look to sell this contract, and your profit potential would be higher, reflecting the additional risk of this trade.
What is at-the-money?
The binary option contract that is closest to the strike price is said to be at-the-money. This is usually priced at around $50, as there is an equal probability of it becoming ITM or OTM. Typically, there is only one binary option contract considered ATM, whereas there could be several that are OTM and ITM. Be aware that a binary option contract cannot expire at-the-money, with regards to the payout criteria. As the question in the binary option strike is phrased as 'greater than', it needs to be one tick or point above the strike to be classed as ITM; if it’s not greater than, but exactly equal to the strike price, then it’s considered OTM from a payout perspective (with the exception of Nadex Events contracts where it is greater than or equal to the strike price to settle ITM). This is important to remember close to expiration - one tick can make all the difference to the settlement of the contract.
In this example, we have a binary option contract that would be considered ATM, as the strike price of 1744.5 is closest to the indicative underlying price of 1743.860. Due to this close proximity, both buyers and sellers have very similar risk to reward ratios.
What is out-of-the-money?
A binary option contract is out-of-the-money when the current market is below the strike price. Those who are selling the contract (i.e. those who believe the current market will be below the strike price at expiration) are more likely to make a profit.
On the order ticket below, we can see the strike price of 1754.50 is higher than the underlying indicative market of 1743.07. In this case, a trader selling the contract could profit in three ways:
The underlying market moves lower.
The underlying market stays the same.
The underlying market moves higher but expires at or below the strike price of 1754.50.
As you can see, the bid/offer prices are below the $50 mark, limiting your potential profit if you were to sell this contract. However, if you believe this market is going to revert back and move in the opposite direction, passing the strike level of 1754.50, you may look to buy this contract. Your profit potential would be higher, reflecting the additional risk of this trade.
ITM, ATM, and OTM binary option examples
Here is an example to illustrate the various possible outcomes for a binary option contract, depending on whether it is ITM, ATM, or OTM.
In this image, you can see that the indicative price for gold is 1743.367. The various strike prices are listed below. They fall into three categories:
ITM. These are contracts where the strike price is below the underlying indicative market (i.e. below 1743.367) – you can see them in the bottom section of the image. Take the strike of >1737.0 as an example. The answer to the question ‘will the strike be above 1737.0’ is already ‘yes’, which is why this contract is ITM. The contracts that are in-the-money give you the highest chance of profiting if you are a buyer. This also means they will be the most expensive to buy.
ATM. This is the strike closest to the indicative price of 1743.367, as shown in the center of the image above (1743.0). At this point, there is a fairly equal chance of the market moving above or below the strike, so the contract’s bid and offer prices will be the closest ones to $50. Note, there is only one strike considered to be ATM.
OTM. A contract is OTM when the underlying market is below the strike price. This applies to the top four strikes in the image, as they are higher than 1743.367. These contracts are less likely to conclude ITM and to be profitable for buyers. As a result, they are generally priced lower for buyers; however, sellers who have the statistical advantage will pay more for these contracts.
Key takeaways
There are myriad strategies for trading binary option contracts. In some instances, you may want to buy ITM binary option contracts where you will pay a premium for a higher probability of profiting. In other cases, you may want to buy OTM binary option contracts, where you secure the trade with a smaller amount of money but have a lower probability of a successful trade. You might adopt this strategy if you predict a big market move.
There is no right or wrong way to trade binary option contracts, whether they are ITM, ATM, or OTM. The strategies you employ will depend entirely on your own trading plan and what you are aiming to achieve.