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 “
For example, say you purchase both a call and a put option on a certain asset with the same expiry. The
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
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
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.
But, some brokers also offer
For example, an OTM% of 85% means that in case you make an
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%)
BE% – Breakeven ratio
Derivation of the Breakeven Formula
In binary options, there are only two outcomes to a trade —
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
X + Y = 1 (the probability that you are going to win plus the probability that you are going to lose is sure.) — eqn. 1
(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%)
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 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
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
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