Time to Expiry (T-t)
We are all aware of the old adage that “time is money”.
In option land, that also holds true and in many cases time to expiry (T-t) is termed the “time value” of the option.
Coming back to probability calculation that the trader makes, the time to expiry adds uncertainty to the calculation. This is indeed true for many other things in life. The more time that we have the more certain we are of reaching an end goal.
This could be completing assignment or reaching a destination on a trip.
When someone is pricing a binary option, the time the option has to expire will impact on their mental calculation of whether they will win the trade. For example, if the binary option is currently out of the money and is 30 seconds to expiry, you can be fairly certain that it will expire and you will lose the trade.
However, if there was still 12 hours to go to expiry then there is still enough time for the option to move into the money before expiry.
How might the Binary Option trader enter a trade based on the time to expire?
Given the unique nature of a Binary Option payoff, a chance for large payoffs is possible when the option is near expiry.
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For example, if the price of the option is quite near the strike price and near expiry, there is the chance of a large swing in the price as it approaches the “all or nothing” payoff.
Taking a look at the above example of the GBP/JPY, if the strike is at 140.50 and the current price is equal to the strike, there is an almost 50% chance that it will either payoff 0 or 100 in a very short period of time.
Hence, a trader who strategically enters the option near expiry can make a rather impressive return on the trade.