Why I Would Avoid Binary Options

Binary Options have become very popular in recent years and if you ever visit a finance site online then you have probably seen ads for binary options all over the place.

When I was putting together information for this article, I had a very hard time finding any “real” website about binary options that wasn’t some type of affiliate site trying to recommend their “favorite” broker. Of course the broker that these sites usually recommend is the one that pays the highest referral commission.

It was really strange as I could not find a single website that said to avoid Binary options except an article on Forbes magazine from 6 years ago?

The big question is are Binaries options worth doing ?

Before I answer that question, lets quickly explain how they work. Binary options are “All or Nothing Options” where you make a “binary” bet meaning that you have only two possible outcomes. You either win or lose.Binary Options overview

You are taking a YES or NO bet like “Will an underlying asset be above a certain price at a certain time?”.

This simplicity is what makes binary options appealing to beginner investors and people like that they have a defined capped risk/reward.

The other allure for people getting into Binary options is that there is minimal capital needed so it caters to those thinking they can make big returns quickly. Like the ads claiming to turn $1,000 into $50,000.

Binaries are different than any other typical trading instrument such as stocks, futures, options, Forex where you have the constant ability to adjust or change your strategy.

Many binary brokerages will give back 10-15% of your “bet” if you lose so you might make 80% maximum payout but lose 85-90%.

Types of Binary Options

  1. Cash or Nothing : Pays you a fixed amount of cash if the option expires in the money.
  2. Asset or Nothing : Pays you the value of the underlying security if it expires in the money

You can find binaries available on stocks, commodities, ETFs, foreign exchange, indexes, and other derivatives.

Are Binaries Regulated ?

Most of the ads and brokers that advertise about binary options are not regulated meaning that they don’t trade on regulated exchanges and you will usually see that the brokers are based overseas from the USA.

There are actually some binary options that are on regulated exchanges like the American Stock exchange(AMEX) that are referred to as “Fixed Return Options” (FRO’s) but the regulated binaries are structured differently.

AMEX Fixed Return Options Calls are named “Finish High” and Puts are called “Finish Low”.

New York Stock Exchange(NYSE) has binaries of their own called Binary Return Derivatives(ByRD)

The exchange regulated binaries are pretty limited and not very liquid in trading. If you want to look them up, some examples of exchange traded binaries are CBOE’s BVZ (represents the VIX) and BSZ (represents the SPX).

Many of the binaries have pretty wide spreads(meaning they are not very liquid) and most USA brokerages don’t allow them because it is hard for their risk programs to deal with them (from what I have read).

Also, since the regulated binaries aren’t hugely popular it probably isn’t a focus for brokerages to add them to their trading platforms. It seems traders would rather trade regulated, liquid instruments like Futures and Weekly options.

Binary Brokers

There are tons of these binary brokers but you have no idea who is really behind the scenes.

I found that popular trading platforms like ThinkorSwim and Interactive brokers don’t offer binaries including the exchange regulated binaries.

Some USA based trading platforms tried offering them but they wasn’t enough interest from customers so they dropped them.

Just a quick look around for Binary Brokers, I found all kinds of brokers I never heard of like:

  • 24option
  • Finpari
  • CherryTrade
  • Binary Book
  • PWRTrade
  • LBinary.com
  • TradoRax
  • CT Option
  • Tropical Trade
  • Trade Thunder
  • Porter Finance
  • Bloombex
  • BankDeBinary.com
  • (there are 100’s more)

What is frustrating is that all the websites I found kept saying “Best USA binary broker” but when I clicked on the broker site(like the ones listed above) they are all based overseas.

Yep, these brokerages are based in popular offshore, unregulated places like Gibraltar, Cyprus, Marshall Islands (The same kind of places where many Online betting sites are based).

Honestly, many of these binany option brokerages don’t seem a whole lot different than online poker sites.

The only CFTC regulated broker with US financial industry oversight I saw is NADEX. They have your funds in a separate USA based client trust account and are regulated by the Commodity Futures Trading Commission(CFTC) and are based in Chicago.

Side note – I think it is crazy that you can put money into a binary account using a credit card so you don’t even need to have the cash to trade binaries.

How Binary Brokers make money

Typically a broker would make money from trading commissions, spreads, and fees but binary brokers have a range of ways they make money.

The most alarming thing to me is that binary brokers can actually work like a casino where they can adjust the payout ratios so they aren’t just providing a platform to trade but making money by adjusting the “odds”.

If you look around online most of the websites that compare Binary brokers will look at the “Payout” percentage listed. For example a broker might like 75% payout so it would pay $75 profit($175 total) for each successful $100 trade and many will pay you 10% or $10 on losing trades.

EXAMPLE: Let do some math on how a Binary options broker would make money on clients:

Assume Broker AAA has 1000 clients. Assume 500 clients of Broker AAA predict that the ABC currency pair will drop in the next hour and each investor put down $100 each on this prediction.

The other 500 clients of Broker AAA forecast that the ABC currency pair will increase in the next hour and thus put down $100 each on this forecast.

The total amount of money pooled between the 1000 clients on ABC currency pair trade is $100,000 ($50,000 on put options and $50,000 on call options).

One hour later we find that ABC currency pair fell which results in 500 clients of Broker AAA to close in the money on their trade.

Let us assume that the payout ratio for the ABC Currency pair trade is 75%. This means that those clients who bet on ABC Currency to fall each get back $175 ($100 capital + $75 profit).

In aggregate, Broker AAA has to pay out $87,500 (500 x $175) to the winners. Some brokers will pay out 10%(maybe 15%) to the losers on the trade so lets subtract $500*$10=$5,000 returned to those clients who lost on the trade.

$100,000 to broker – $87,500 to winners – $5,000 to losers = $7,500 broker gets to keep.

Now multiply this on lots of trades and you can see why there are so many Binary options brokers that have popped up in recent years.

One thing I wonder about is how much the broker will adjust the spreads on trades to always keep the odds in their favor? (Remember, most of these binaries are not part of A REGULATED MARKET.)

Do People Make Money Trading Binary Options ?

I am sure there are some traders that make some money on Binary options just like there are some gamblers that make money off the casino but over the time the odds are in the favor of the brokers.

Say you are successful on 55% of your trades (NOTE- you can be profitable as a trader at 55% if you keep your loses small but with Binaries your loses are 85-90% each time). For 1000 trades that would be 550 winners.

55% winners = 550 winning trades x $75 payout = $41,250

45% Losers – 450 losing trades x $90 loss($100-$10)*90 = $40,500

** Note many binary sites list “Maximum” payouts for binary brokers but that is MAXIMUM and not the payout for all trades, so if you are jumping around to different payouts then your #’s could be even worse than this.

You can see that the profit is minimal ($750) even after 1000 trades and that assumes no other fees paid.

Summary, You better have a damn good win/loss trade % to really make money with Binaries because you are capped on the upside and the losses are large when you are wrong.

CONCLUSION

Would I Trade binaries ?

NO and here is why:

1. If I am smart enough to know exactly what level and by what time an underlying instrument is going to move then why would I buy a binary option with capped upside ? Just buy the stock, or a deep in the money call or put(that will trades like the underlying asset with no capped upside) or futures.

2. I don’t like how the binary brokerages have different payouts and seem to be more like casinos. Look at the math I did above.

3. With Binary options brokers, I feel like I would be betting against the “house”. We all know who wins in the end….the casino.

4.  I would never put money in an overseas unregulated brokerage(not sure they are even considered “brokerages”) that doesn’t have financial regulatory oversight. You are making a bet that your brokerage is solvent and that your funds are properly held in a trust account.

Summary

You are much better off learning to trade in a liquid, regulated asset like Stocks, Options or index futures. You have a lot more flexibility and can control losses better.

Binaries seems to target the same audience of people who like to gamble or might not have much funds (Kind of like penny stocks industry).

You see, in trading you need to let your winners run and have your risk/reward in your favor. With binaries you are capped on the upside and the risk/reward can work against you since you take large losses every time you are wrong.

What are your thoughts ?

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