Normally, analyzing potential profits on financial derivatives could be considered a pretty daunting task. One must take into account trading fees and the magnitude of price movements in order to get a picture of where profits fall depending on price. With binary options, however, these complications are totally erased. It serves to simplify the profit breakdown and help traders fully identify and quantify risks they’re taking with relative ease.
If they were to be graphed, binary options profit models could be formed with a series of horizontal and vertical lines. Picture an X axis that is designated by price of the underlying asset. The Y axis, meanwhile, would be profit. The break even line would be towards the middle of the Y axis, extending all the way out. On a call option, a horizontal line (representing profit) would come out of the Y axis to the right and stay under that break even point to represent the fixed loss from a contract that finishes out of the money. Then, when strike price is hit as the line moves parallel to the X axis, the profit line would take a sharp vertical turn all the way up to the fixed gain (on the Y axis) from a binary options contract that finishes in the money. The line would then turn horizontal again, because it is impossible to win more than the fixed gain specified in the contract.
It is also useful in a profit breakdown of binary options to consider the break-even point for multiple trades. This probability-based calculation tells traders the percentage of trades they must win in order to break even. The only information needed is the amount gained from “in the money” binary options contracts and the amount lost on “out of the money” contracts. By subtracting these amounts multiplied by their occurrence percentage (out of 100) and setting the equation equal to zero, the break even percentage of “in the money” trades needed can be seen. If a call binary option worth pays 70% on winning trades and keeps 85% on losing trades, then the break even percentage can be found as follows: 0=70(A)-85(1-A). Simplified, this equation works out to a 54% success rate in order to be successful.
Whether it is a single trade or an entire portfolio, knowing the break-even and profit breakdown of the binary options trades one enters is essential to managing risk. With a little practice, investors will be able to almost automatically assess potential gains and performance needed in order to be successful.