From Wikipedia, the free encyclopedia
A binary option is a financial option in which the payoff is either some fixed monetary amount or nothing at all.
While binary options theoretically play a role in asset pricing and are a form of financial derivatives, they have been banned by regulators in many jurisdictions as a form of gambling, and many binary option outlets have been exposed as scams.
The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. They are also called all-or-nothing options, digital options (more common in forex/interest rate markets), and fixed return options (FROs) (on the American Stock Exchange).
Though binary options sometimes trade on regulated exchanges, they are generally unregulated, trading on the internet, and prone to fraud. The U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have issued a joint warning to American investors regarding unregulated binary options, and have forced a major operator, Banc de Binary, to cease operations in the US and pay back all customer losses.
Many binary option "brokers" have been exposed as questionable operations. With such binary option brokers, there is no real brokerage; the customer is betting against the broker, who is acting as a bucket shop. Manipulation of price data to cause customers to lose is common. Withdrawals are regularly stalled or refused by such operations.
In Israel, where a high concentration of such firms can be found, binary options trading was prohibited for Israeli customers in March 2016, on the grounds that it is a form of gambling and not a legitimate investment technique. A ban on marketing of binary options to overseas customers is under consideration.
How binary options work
Binary options "are based on a simple 'yes' or 'no' proposition: Will an underlying asset be above a certain price at a certain time?" Trades place wagers as to whether that will or will not happen. If a customer believes the price of a commodity or currency will be above a certain price at a set time, he buys the binary option. If he believes it will be below that price, he sells the option. The price of a binary is always under $100.
Investopedia described the binary options trading process in the U.S. thusly:
[A] binary may be trading at $42.50 (bid) and $44.50 (offer) at 1 p.m. If you buy the binary option right then you will pay $44.50, if you decide to sell right then you'll sell at $42.50.
Let's assume you decide to buy at $44.50. If at 1:30 p.m. the price of gold is above $1,250, your option expires and it becomes worth $100. You make a profit of $100 - $44.50 = $55.50 (less fees). This is called being "in the money."
But if the price of gold is below $1,250 at 1:30 p.m., the option expires at $0. Therefore you lose the $44.50 invested. This called "out of the money."The bid and offer fluctuate until the option expires. You can close your position at any time before expiry to lock in a profit or a reduce a loss (compared to letting it expire out of the money).
Every option settles at $100 or $0, $100 if the bet is correct, 0 if it is not.
On non-regulated platforms, client money is not necessarily kept in a trust account, as required by government financial regulation, and transactions are not monitored by third parties in order to ensure fair play.
Binary options are often considered a form of gambling rather than investment because of their negative cumulative payout (the brokers have an edge over the investor) and because they require little or no knowledge of the markets. Gordon Pape, writing in Forbes.com in 2010, called binary options websites "gambling sites, pure and simple," and said "this sort of thing can quickly become addictive... no one, no matter how knowledgeable, can consistently predict what a stock or commodity will do within a short time frame."
Pape observed that binary options are poor from a gambling standpoint as well because of the excessive "house edge." One online binary options site paid $71 for each successful $100 trade. "If you lose, you get back $15. Let's say you make 1,000 "trades" and win 545 of them. Your profit is $38,695. But your 455 losses will cost you $38,675. In other words, you must win 54.5% of the time just to break even." 
The U.S. Commodity Futures Trading Commission warns that "some binary options Internet-based trading platforms may overstate the average return on investment by advertising a higher average return on investment than a customer should expect given the payout structure."
Binary options trading in the U.S.
In the U.S., the Securities and Exchange Commission approved exchange-traded binary options in 2008. Trading commenced on the American Stock Exchange and the Chicago Board Options Exchange (CBOE) in May and June, 2008.
Amex offers binary options on some exchange traded funds and a few highly liquid equities such as Citigroup and Google. Amex calls binary options "Fixed Return Options" (FROs); calls are named "Finish High" and puts are named "Finish Low". To reduce the threat of market manipulation of single stocks, Amex FROs use a "settlement index" defined as a volume-weighted average of trades on the expiration day. Amex and Donato A. Montanaro submitted a patent application for exchange-listed binary options using a volume-weighted settlement index in 2005.
Fraud and regulatory actions
The Australian Securities & Investments Commission (ASIC) warned Australian investors on Friday 13 February 2015 against Opteck, an unlicensed binary option provider. The ASIC later began a focused effort to control unlicensed derivative providers, including "review" websites, broker affiliates and managed service providers related to binary option products.
On May 3, 2012, the Cyprus Securities and Exchange Commission (CySEC) announced a policy change regarding the classification of binary options as financial instruments. The effect is that binary options platforms operating in Cyprus, where many of the platforms are now based, would have to be CySEC regulated within six months of the date of the announcement. CySEC was the first EU MiFID-member regulator to treat binary options as financial instruments.
In March 2013, the Malta Financial Services Authority announced that binary options regulation would be transferred away from Malta's Lottery and Gaming Authority. On 18 June 2013, Malta’s Financial Services Authority confirmed that in their view binary options fell under the scope of the Markets in Financial Instruments Directive (MiFID) 2004/39/EC. With this announcement Malta became the second EU jurisdiction to regulate binary options as a financial instrument; providers will now have to gain a category 3 Investment Services licence and conform to MiFID's minimum capital requirements. Prior to this announcement it had been possible for firms to operate from the jurisdiction provided the firm had a valid Lottery and Gaming Authority licence.
In 2013, CySEC prevailed over the disreputable binary options brokers and communicated intensively with traders in order to prevent the risks of using unregulated financial services. On September 19, 2013, CySEC sent out a press release warning investors against binary options broker TraderXP; CySEC stated that TraderXP was not and had never been licensed by CySEC. On October 18, 2013, CySEC released an investor warning about binary options broker NRGbinary and its parent company NRG Capital (CY) Ltd., stating that NRGbinary was not and had never been licensed by CySEC.
The Cypriot regulator also temporarily suspended the license of the Cedar Finance on December 19, 2013. The decision was taken by CySEC because the potential violations referenced appeared to seriously endanger the interests of the company’s customers and the proper functioning of capital markets, as described in the official issued press release. CySEC also issued a warning against binary option broker PlanetOption at the end of the year and another warning against binary option broker LBinary on January 10, 2014, pointing out that it was not regulated by the Commission and the Commission had not received any notification by any of its counterparts in other European countries to the effect of this firm being a regulated provider.
The Cyprus regulator imposed a penalty of €15,000 against ZoomTrader. OptionBravo and ChargeXP were also financially penalized. CySEC also indicated that it had voted to reject the ShortOption license application.
In 2015, CySEC repeatedly fined Banc De Binary for several violations including the solicitation of US clients. In 2016, the regulator fined Banc De Binary Ltd once again for violation of its legislation. The broker has come to a settlement of €350,000.
The Times of Israel has run a series of articles, "The wolves of Tel Aviv: Israel's vast, amoral binary options scam exposed" exposing the industry as a scam. In a second article, the Times describes in detail how an binary options salesman fleeced clients. "According to one ex-employee of a firm that employs over 1,000 people in a high-rise office building in Tel Aviv, losses are guaranteed because the 'dealing room' at the binary options firm controls the trading platform — like the crooked ownership of a rigged casino manipulating the roulette wheel." 
In March 2016, binary options trading within Israel was banned by the Israel Securities Authority, on the grounds that such trading is essentially gambling and not a form of investment management. The authority is considering extending the ban to overseas clients as well. The chairman of the Securities Authority asked Israel's Attorney General to amend the law so as to allow such a ban. Binary options comprises 63%, or $1.25 billion, of Israel's $2 billion securities and derivatives industry, which contributed 0.7% of the country's gross domestic product during 2016.
In July 2016, the Israeli binary option firms Vault Options, Ltd. and Global Trader 365 were ordered by the U.S. District Court of Northern Illinois to pay more than $4.5 million for unlawful off-exchange binary options trading, fraud, and registration violations. The companies were also banned permanently from operating in the US or selling to US residents.
In November 2016, the Israel Securities Authority carried out a raid on the Ramat Gan offices of binary option broker iTrader. The CEO and six other employees were charged with fraud, providing unlicensed investment advice, and obstruction of justice.
On June 6, 2013, the U.S. Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission jointly issued an Investor Alert to warn about fraudulent promotional schemes involving binary options and binary options trading platforms. The two agencies said that they had received numerous complaints of fraud about binary options trading sites, "including refusal to credit customer accounts or reimburse funds to customers; identity theft; and manipulation of software to generate losing trades." Other binary options operations were violating requirements to register with regulators.
In 2013, U.S. regulators charged Israeli-Cypriot Banc De Binary Ltd., with illegally selling binary options to U.S. investors. Three years later, the company reached an $11 million settlement with U.S. authorities. Regulators found the company used a "virtual office" in New York's Trump Tower in pursuit of its scheme, evading a ban on off-exchange binary option contracts.The company neither admitted nor denied the allegations.
- Option (finance)
- Options strategies
- Options spread
- Options arbitrage
- Synthetic position
- Prediction Market
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