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Payout Levels: Binary Options Income
hello everyone and welcome back to our binary options basics series in this video we'll discuss the payout levels from the options brokers and what that means for you as the traitor you'll learn how to use these payout levels to analyze individual trades and to evaluate your overall trading strategy in addition you'll gain some insight into the trades from the broker standpoint by learning about the brokers spread in the transaction so let's start the first thing we're going to do is we're going to go to the bank de binary options trading screen at the top is the currency pair EU our and USD at the bottom is the currency pair AUD vs USD let's look at the bottom option which expires in just a few minutes the currency pair is currently trading at about one point oh 16 and the site is constantly updating the strike price to be equal to the current trading level this binary option has a potential payout of 75 percent of the initial investment and the payout is the same whether we're interested in a call or a put this means that if we're correct in our prediction we will earn back our initial investment plus an additional seventy-five percent profit let's say we analyze this pair and we decide that we think the price is going higher in that case we'll click on up the trading box will ask us to enter an investment amount for now let's enter a hundred dollars in future videos we will discuss how to allocate your trading capital across multiple trades so we invest a hundred dollars if we're correct we will earn our initial $100 back plus an additional $75 total of a hundred and seventy five dollars how do we decide if this is a good investment well let's think about it in terms of probability in a binary option as the name implies the outcome is binary that is only two outcomes or possible the first possible outcome is that the asset finishes below the strike price in which case we lose our one hundred dollar investment the second possible outcome is that the asset finishes above the strike price in which case we make a profit of $75 we want to know the probability that we're correct and the asset finishes above the strike price let's call that X the probability that we're wrong and the asset finishes below the strike price is 1 minus X since those are the only two possibilities and the probabilities must sum to 1 the expected value of this trade is represented by this formula 75 x plus a negative 100 times 1 minus X and for our trade to be profitable it must have a positive expected value so let's set this expression greater than 0 solving for x we get a probability of at least fifty seven percent therefore the probability that the probability that the asset finishes above the strike price must be at least fifty seven percent for us to make this trade and the probability that the acid finishes below the strike price must be less than forty three percent so what does that mean for the traitor well there are two ways to think about it the first way is as a deciding factor for the individual trade on a standalone basis if we buy the call option we're saying that we think there's a greater than fifty seven percent probability that the asset will be higher than the strike price at expiration for example if we think there's a 75 percent chance that the asset is going higher we should of course do this trade but if we think there's only a 50 or 51 percent chance that the assets going higher we should not do this trade so not only do we have to think it's more likely than not but we have to be fairly certain that the assets going to be above that strike price in order to do this trade the second way to think about this is as a way to evaluate our overall trading strategy if we were to invest in a portfolio of binary options each day we can assume that we're not going to make money on every single trade to make money every day we'll need our success rate that is the percentage of profitable trades to exceed fifty-seven percent that's assuming they all have that same 75% payout potential if we're not able to meet this hurdle and we're finding that day in and day out our success rate is lower than 57% we're going to need to reevaluate our trading strategy so this is why it's so important when it comes to your trading strategy that you're very confident in your trades it has to be more than fifty seven percent chance in this example that the assets going to be above that strike price at expiration when it comes to a long-term successful trading strategy there's another numerical analysis that we need to discuss and it's related to the 75% payout and our success rate and that number is the broker spread for the options so think of the broker as the casino for a blackjack bed or a bookie for a sports bet the brokers goal is to make opposing trades and lock in what's called the spray so what is the spread well remember the broker pays out seventy-five percent of the initial investment on a put or a call they give the same payout let's take a simple example where the broker has one underlying and one strike price let's assume the broker is successful in building a book of puts and calls in exactly equal amounts when the option expires only one of the options will be in the money either the calls or the puts let's say it's the calls that expire in the money and pay out the seventy-five percent profit the put options will expire worthless and the broker will collect one hundred percent of the investment for the puts the brokers net profit is the one hundred percent that they receive from the put buyers minus the seventy-five percent that they pay out for the call buyers for a net of twenty-five percent that twenty-five percent is called the spread in theory if our trading strategy was not advantaged at all where we were equally likely to be right or wrong on each trade then we would just consistently day in and day out be losing that twenty-five percent spread over time in order to make money we need to be right more often than we're wrong in order to pay for that brokers spread so that's why it's so important that we develop a smart trading strategy