Exiting Your Trade Before Expiration-Option Strategies

With binary options you do not have to wait for the contract to expire to exit your trade. You may want to exit your trade prior to expiration for one of two reasons: (1) to lock in your profit or (2) to minimize your losses.Exit to Lock In Profit:If you wait until expiration and the underlying ends up even one cent below your strike price, you will get $0 instead of $100 per contract at settlement.

Therefore, you may not want to take that chance and exit that trade prior to expiration if your trade is profitable. You simply may want to lock in the profit on your trade prior to settlement. Let’s examine this principle with two basic examples.Example 1 (Long Position) Let’s use a long binary option trading position to demonstrate why you would want to lock in your profit prior to expiration.

Entry Breakdown Let’s assume that the S&P futures are trading at 1250 when you place your trade. You purchase a “> 1244” option in the morning with the assumption that the underlying will be above 1244 at the end of the day. You decide to buy one contract for $73.90.In Exhibit 6.8, the y?axis represents available strike prices.

The dark grey dashed line represents the market price of S&P futures and the light grey dashed line represents the binary option contract. With one day until expiration, the 1244 binary option is purchased with the assumption that the S&P futures will close above 1244 at expiration.You exit the position early when the bid price is $85, giving you a total profit of $11.10. Your profit is calculated by simply subtracting $73.9 (your purchase collateral) from $85 (the bid price of the option when you decide to exit your trade).

To do this, you simply sell the “> 1244” option and lock in your profit.Example 2 (Short Position) Now let’s use a short binary option trading position to demonstrate why you would want to lock in your profit prior to expiration.Entry Breakdown Based on the same option chain we discussed, let’s assume again that the S&P futures were trading at 1250 when you entered your trade. But this time you sold the “> 1241” option in the morning with the anticipation that the underlying will go down by the end of the day.

The option’s bid price is $79.9; therefore, you put up $20.1 collateral per contract.In Exhibit 6.12, the y?axis represents available strike prices. The dark grey dashed line represents the market price of S&P futures, and the light grey dashed line represents the binary option contract. With one day until expiration, the 1241 binary option is sold with the assumption that the S&P futures will close below 1241 at expiration.Exit Breakdown As expiration approaches, the S&P futures drop and are priced at 1244.

The price of the “> 1241” option goes down to $65.You become concerned that the S&P futures will rebound and decide to exit your trade early. In order to do this, you will now need to buy back the “> 1241” option.Since initially you sold the option for $79.9 and now you are buying it back at $65, your account will be credited the difference between the two strike prices. This figure is $14.9.

Additionally, you will receive your trade collateral back since you exited your trade. So for a max risk of $20.1 per contract, you will receive a reward of $14.9 per contract.In Exhibit 6.13, the y?axis represents available strike prices. The dark grey dashed line represents the market price of S&P futures, and the light grey dashed line represents the binary option contract.

As expiration approaches,the S&P futures have fallen six points and are currently trading at 1244.Exit to Minimize Losses:Let’s assume that you enter into a binary options contract and it’s simply not working out in your favor. The way things are going, it clearly looks like you are going to lose on the trade and the underlying is going to end up in a situation where your contract will be worth $0 at expiration.One great feature of binary options is that you do not have to wait until expiration and lose your entire collateral. You can simply cut your losses short by exiting the trade before expiration and preserve at least a portion of your investment on the trade.