Binary options tunnel theta describes the rate of change in the fair value of a binary options tunnel over time until expiry. Theta indicates how quickly the value of the tunnel option changes over time. This metric, which is mathematically derived as the first derivative of the option’s fair value over time, provides information about the sensitivity of the option price to the passage of time.
Metrics are used in binary options trading to make the best possible predictions about what will happen in the market. While no binary options trading indicator alone can guarantee you the success of a trade, Tunnel Theta is still a remarkable help if used accordingly.
Binary Options Tunnel Theta in a nutshell
- Binary options tunnel theta measures the option’s fair value change over time until expiry.
- It indicates how sensitive the tunnel option price is to time passage.
- Tunnel theta can be mathematically represented as the derivative of the option’s fair value with respect to time.
Should Tunnel Theta be used as the sole indicator?
Although Tunnel-Theta is a helpful metric for mathematically evaluating an investment decision, it should not be used as the sole indicator. It is much more critical to predict the market direction. Therefore, it is important to add implied volatility to make a more informed investment decision.
Once implied volatility has fallen to a point where it is below 15%, the theta profile between strikes becomes zero. What we can observe here is very interesting. Despite the drop in volatility, the profiles between strikes initially equalize before dropping back toward zero. This can be a useful entry point for traders to speculate that the price range will move within this range.
How is Binary Options Tunnel Theta represented mathematically?
Mathematically, Binary Options Tunnel Theta can be represented as the derivative of the option’s fair value with respect to time until expiration. Symbolically, it can be expressed as:
- ΘTunnel: Rate of change of option’s fair value over time
- V: Fair value of the option
- t: Time until option’s expiration
- dV/dt: Derivative of option’s fair value with respect to time
How does time affect Binary Options Theta?
Let’s look at the tunnel theta of binary options in terms of the time remaining until an option expires. Here, the utility of this metric becomes clear.
Suppose the 25-day binary options theta profile is flat and has a very small theta. Furthermore, suppose the Theta is close to zero in the 10-day theta profile. In that case, there is a high probability that buying between strikes is beneficial and outside strikes are unfavorable. Consider using other metrics to predict whether you should place a bullish or a bearish trend.
Find more articles in my Binary Options Glossary.