# Digital Options

As you can see, the price of at-the-money options will change more significantly than the price of in- or out-of-the-money options with the same expiration.

Futures, options, and swaps trading involve risk and may not be appropriate for all investors. Vega is the amount call and put prices will change, in theory, for a corresponding one-point change in implied volatility.

For example an up and in call option can be booked and hedged as a combination of a call spread with strikes being barrier and barrier - overdhedge and a call option with strike equal to the barrier level.

## What is a 'Digital Option'

So delta has increased from. So delta in this case would have gone down to. This decrease in delta reflects the lower probability the option will end up in-the-money at expiration. How delta changes as expiration approaches Like stock price, time until expiration will affect the probability that options will finish in- or out-of-the-money. Because probabilities are changing as expiration approaches, delta will react differently to changes in the stock price.

If calls are in-the-money just prior to expiration, the delta will approach 1 and the option will move penny-for-penny with the stock. In-the-money puts will approach -1 as expiration nears. If options are out-of-the-money, they will approach 0 more rapidly than they would further out in time and stop reacting altogether to movement in the stock. Again, the delta should be about. Of course it is. So delta will increase accordingly, making a dramatic move from.

So as expiration approaches, changes in the stock value will cause more dramatic changes in delta, due to increased or decreased probability of finishing in-the-money. But looking at delta as the probability an option will finish in-the-money is a pretty nifty way to think about it. As you can see, the price of at-the-money options will change more significantly than the price of in- or out-of-the-money options with the same expiration.

Also, the price of near-term at-the-money options will change more significantly than the price of longer-term at-the-money options.

So what this talk about gamma boils down to is that the price of near-term at-the-money options will exhibit the most explosive response to price changes in the stock.

But if your forecast is wrong, it can come back to bite you by rapidly lowering your delta. But if your forecast is correct, high gamma is your friend since the value of the option you sold will lose value more rapidly. Theta Time decay, or theta, is enemy number one for the option buyer. Theta is the amount the price of calls and puts will decrease at least in theory for a one-day change in the time to expiration.

Notice how time value melts away at an accelerated rate as expiration approaches. In the options market, the passage of time is similar to the effect of the hot summer sun on a block of ice. Check out figure 2. At-the-money options will experience more significant dollar losses over time than in- or out-of-the-money options with the same underlying stock and expiration date.

And the bigger the chunk of time value built into the price, the more there is to lose. Keep in mind that for out-of-the-money options, theta will be lower than it is for at-the-money options. However, the loss may be greater percentage-wise for out-of-the-money options because of the smaller time value. The price of 64 is essentially the probability the binary will expire in the money. Using the same example where the underlying market is trading around By selling this binary strike level, the trader thinks that the underlying market will not close above At expiration if this binary remains OTM then the binary will expire worthless under In this instance, the delta for this strike price could be considered 0.

Why would any trader consider this scenario? Option Prices Always Changing If you have ever traded binary or equity options, you know that prices are constantly changing.

One of the reasons option prices are changing is due to option gamma for equity options and the perceived gamma in binary options. Option gamma increases the closer the option gets to expiration. The closer the option gets to expiration the more the delta may change because of the delta being either 0 or 1.

This is why the gamma grows larger and can affect the delta more as the option heads into expiration. Perceived Option and Gamma Although there is no gamma attached to binary options, the prices change just like they would over time with equity options.

The best way to understand this principle using binary options is to imagine the underlying that trades sideways as it heads closer to expiration. Going back to our example above where the ITM binary option was purchased with a strike price of The binary is already ITM so the binary price will continue to rise, because of the increasing delta or probability of the binary expiring in the money. That probability increases because now there is less time. For example, the original cost of the If the underlying market remains relatively quiet, with only two hours left until expiration, the binary price might increase up to

## (At least the four most important ones)

Call options are bought when the price of the underlying is expected to rise. Put options are bought when the underlying is expected to fall. Bullish Digital Option Example. Nadex is a regulated digital options broker in the U.S. The platform provides strike prices and expirations for various underlying assets.