Break Even Ratios in Binary Trading

In binary options trading, the break even ratio is the percentage of the correct predictions you need to make in order for you not to lose any money. If your percentage of accurate predictions coincides with the break even ratio, then you will not lose money but you will also not make any money at all. It is therefore your task as a binary options trader to keep practicing your strategies while keeping your risk factors low.

As we have already established, binary options trading allows you to make money if you predict the future movement of an asset. In order to be able to make a prediction, you will have to invest a certain sum of money. Knowing the movement trends and the daily market news is essential to making the right prediction, as we have mentioned in the other articles.

If you make a correct prediction, your trade results “in-the-money”. You will be paid out with the repayment of your investment plus a certain percentage of that investment. In most cases this percentage is never 100%. This means that correctly predicting 50% of your predictions will not necessarily mean mean that you will breakeven.

For example, say you purchase both a call and a put option on a certain asset with the same expiry. The in-the-money percentage (ITM%) awards you with 70% of your investment, while the broker (or you) dictate an out-of-the-money percentage (OTM%) of 90%. This means that if you win in-the-money, and lose out-of-the-money, the break even ratio will be less than 50% since 70% is not equal to 90%.

In order to break even, meaning not lose anything but also not win anything, you will need have to have a break even percentage of above 50%. Most traders do not even have a clue that this rate even exists. It is up to you to play around with your ITM% and the OTM% plus the other risk factors pertaining to your trade in order to at least break even, if not end up in-the-money.

How to Calculate Breakeven Ratio in Binary Trading

Fortunately, with basic algebra and probability theory, it is not that hard to calculate the breakeven ratio. The only things you will have to know about are a few parameters. As we discussed earlier in the example, these parameters include the in-the-money percentage (ITM%) and the out-of-the-money percentage (OTM%). Using these, you will be able to easily calculate your breakeven ratio and optimize your trading techniques.

In-The-Money Percentage

The in-the-money percentage (ITM%) is the ratio of the profits you will be making in case you make a correct prediction. In other words, this is the percentage of your investment that is basically the payout percentage offered by brokers. Many brokers offer different ITM% for different assets. Some brokers allow you to modify the ITM% through their options builder.

For example, a payout percentage of 80% means that in case you make an accurate prediction, the broker will repay your investment and offer you a commission of 80% of the investment amount. If you invested $100, then the total returns you will be getting will be $100 plus $100 x 0.8 for a total of $180.

Take note, ITM% is the percentage of your investment as winnings from the broker.

Out-Of-The-Money Percentage

The out-of-the-money percentage (OTM%) is the ratio of your investment the broker will take away in case you do not make an accurate prediction. In most cases, when you make an inaccurate prediction the broker will take away all the money you have invested. In this case, the out of the money percentage is 100%.

But, some brokers also offer so-called rebates or refunds. Rebates basically represent the percentage of your investment the broker will not take away in case of an inaccurate prediction. Most common rebates range between 5% to 15%. So, if a broker offers rebates of 15% on losing trades, then your out of the money ratio is 85%.

For example, an OTM% of 85% means that in case you make an out-of-the-money prediction, the broker will take away 85% your investment and offer you a rebate of 15% of the investment amount. If you invested $100, then the total returns you will be getting will be $100 minus $100 x 0.85 (or $100 x 0.15) for a total of $15.

Again, take note that OTM% is the percentage of your investment that the broker takes when you lose.

Breakeven Ratio Formula

The formula to calculate the breakeven percentage is the following:

BE% = OTM% / (ITM% + OTM%)

where

BE% – Breakeven ratio

ITM% – In-the-money percentage

OTM% – Out-of-the-money ratio

Derivation of the Breakeven Formula

In binary options, there are only two outcomes to a trade — in-the-money, or successful, and out-of-the-money, or unsuccessful. In probability theory, where the probability of an event is represented by a percentage (or a fractional number from 0 to 1, where 0 means the event is not going to happen and 1 means the event will sure to happen), we can say that the probability of in-the-money trades plus the probability of out-of-the-money trades is equal to 1 (if the trade is not in-the-money, it’s out-of-the money, and vice versa).

This binary state allows us to derive the break even percentage, if we equate both probabilities multiplied by both ITM% and OTM%.

So let X be the probability that you are in-the-money, and Y is the probability that you are out-of-the-money.

X + Y = 1 (the probability that you are going to win plus the probability that you are going to lose is sure.) — eqn. 1

and

(ITM% x X) — (OTM% x Y) = 0 (equating this to 0 means we’re getting the break even percentage, meaning that if we transpose one term to the right of the equation, we get an equality) — eqn. 2

Representing eqn. 1 in terms of Y gives

Y = 1 — X — eqn. 3

Substituting eqn. 3 to eqn. 2 and Y is eliminated.

(ITM% x X) — (OTM% x (1 — X)) = 0 eqn. 4

Eqn. 4 is a linear equation with a single unknown X gives us the break even percentage.

(ITM% x X) — (OTM% x (1 — X)) = 0

Distributing (OTM% x (1 — X)) yields

(ITM% x X) — OTM% + (OTM% x X) = 0

Collecting all X’s together on one side of the equation yields our formula for the break even ratio.

X = OTM% / (ITM% + OTM%) (where X is the probability that you should win in order to break even, or simple the break even ratio BE%)

Example

In order to understand these better, let’s have an example that involves the breakeven ratio.

Assuming that a broker offers a payout rate of 80%, meaning that the in-the-money percentage (ITM%) is 80%. The broker also does not offer any kind of rebates at all, meaning that the out-of-the-money percentage is 100%, or the broker will take away all loses.

In this case, one can easily calculate the BE% in the following way:

BE% = 100% / (100% + 80%)

Removing the percentages for the calculation’s sake and we have

BE% = 100 / (100 + 80)

BE% = 100 / 180

BE% = 0.5555

Adding back the percentages and we have

BE% = 0.555 * 100

Bringing us to

BE% = 55.55%

This means that in the case of a payout rate of 80% and 0% rebates, you will have to accurately predict 55.55% of your investments in order not to lose any money at all.

Example With Rebates

What if a broker gives a rebate? Let’s stick to our previous example of a payout rate of 80%, as in, an in-the-money percentage (ITM%) of 80%. Now, imagine that a broker offers a rebate of 10%. In this case, the out-of-the money percentage (OTM%) is 100% -minus the rebate, which in this case is 10%, so the OTM% is 90%.

Using the formula we have

BE% = 90% / (90% + 80%)

and this results to:

BE% = 52.91%

As seen in this case, a trader will only have to accurately predict 52.91% of the trades in order not to lose any money at all. It is quite obvious how choosing a broker that offers a rebate is more advantageous as the break even percentage is lower.

In conclusion, calculating break even ratios in binary options trading is important for risk management. As explained initially, knowing the break even ratio from the payouts and the losses will allow you to strategize as to which in-the-money and out-of-the-money percentages are optimal. Understanding the above-mentioned parameters is extremely important if you want to become a successful binary options trader. For this reason, we strongly recommend that you perform these calculations first before entering a trade with your binary options broker.

Speaking of binary options brokers, our site lists the top brokers to date. Pick one and start applying your strategies today.