Open Interest and Binary Options Trading

Binary options can be used to create profitable strategies, and there is a lot of information available that an investor can use to determine if the price of an option will move in the near term.  One very effective way to profit from specific information is to analyze the volume and open interest of a specific standard option contract to determine if a specific financial instrument could move dramatically because many investors are involved and have large exposure to small price moves.

Standard options give an option buyer the right, but not the obligation to purchase the underlying asset at a specific price at a specific time.  The specific price is called the strike price, and the time is called the expiration date.  As options move closer to their expiration date, they normally trade close to a specific strike price.  The larger the open interest around a strike price the more likely the underlying asset will trade in a range near that strike.  The reason this occurs is that investor who is both long and short a particular option has an incentive to keep the asset in the money with relation to their option position.  For example, if a trader had a large position in WTI NYMEX Crude Oil Call options, (say 5,000 contracts or 5 million barrels worth of crude oil), with a strike at $85 dollars per barrel, the investor would want to keep the market above $85 dollars until the option expired.  At the same time, there will be investors who sold these options who would have an incentive to keep the WTI Crude Oil market below $85 dollars a barrel until the option expired.

As the market trades around a specific strike price, close to the expiration date of the option, the investor who is long has a large delta (position) when the option is in the money, and has a very small position, when the option is out of the money.  The delta is a term used to define the risk an investor has to the directional movement of an underlying asset.  For an investor who owns a call option, their delta becomes larger and larger as the price of WTI increases, and becomes smaller and smaller as the price of WTI decreases.  The opposite would be true for a call option seller.  For an option owner who has call options with a strike of $85 dollars per barrel, the option on expiration has a full delta (in the example above 5 million barrels) if the option expires in the money, and has no delta if the option expires out of the money.  With this in mind, the position (what position they will receive) of the option buyers and the option sellers are unknown as an option is about to expire.  If there is a large open interest around a specific strike, the market can move violently and with a lot of volatility as the options expire.

One way to determine if this is going to occur is to look at the open interest of different financial instruments.  An example is the July WTI call option listed on the Chicago Mercantile Exchange chart.  This table lists the option interest and estimated volume of WTI call options for July expiration.  Two specific options for this date that seem to have a large open interest are the $80 call options and the $85 dollar call options.  The $80 dollar call option has an open interest of 9225 contracts, which are equivalent to 9.225 million barrels of crude oil, and the $85 dollar call option has an open interest of 7995 contracts, which is equivalent to 7.995 million barrels of crude oil.

A strategy that a binary option trader could use is to purchase a hit option on both sides of a strike price as the options on the standard contracts are about to expire.  For example, let us assume WTI crude oil was trading at $85 dollars an hour prior to the end of trading for a session where the option for the July contract was going to expire.  An investor could purchase an 85.25 hit option and a 84.75 hit option, with the idea that on expiration, the market will move quickly in one direction or another.  Another strategy might be to purchase miss options at the time leading into the expiration, with the idea that the underlying asset will stay very close to a strike price with large open interest on the day the options are going to expire.

There are numerous strategies that can be used by using available information supplied by exchanges to take advantage of the flexibility and dynamic nature of the binary options market.