BY LAMON RUTTEN

Understanding Binary Option

A binary option is a derivative with an “all or nothing” payout: as an option buyer, you take a view on whether the price of a certain asset (a commodity, a stock, an exchange rate, an index…) will go up or down over a certain time period, or will be above or below a certain number at a certain time; or will touch a certain price within a certain time frame… There are many different scenarios/types of binaries, but what they have in common is that if you are wrong you lose most or all of your investment, if you are right you make an immediate profit. An example, for one of the types of binary options available for gold (one of the most traded commodities):

• A “no touch” binary option for gold, for a gold price of USD 1,295 per oz, and valid for 30 minutes trades at a “bid” of USD 40, and an ask of USD 42. The option becomes worth USD 100 when the “prediction” becomes true at or before the expiry time of the option (USD 100 is the standard payout on a winning binary option, but other amounts are possible).
• If you buy this option, the premium cost is USD 42; you will win USD 100 if the gold price over the next 30 minutes is never at or above USD 1,295.  If you sell this option, the premium cost is USD 40. You win USD 100 if at any time during the next 30 minutes, the gold price touches USD 1,295.
• Let’s say you sell this option, but the gold price does touch USD 1,295. You lose the full USD 40. But if the gold price did not touch USD 1,295, your get a payout of (USD 100 – 40 =) USD 60. Let’s say the deposit that you had prior to starting to trade was USD 50; now, after a successful trade and 30 minutes later, you have USD 110. 

In practice, the market has developed towards extremely short-term trading, with time periods as short as 30 seconds. With this kind of time frames, binary options trading in fact has become a kind of gambling, and that’s how many binary option users started using the instrument, with all the associated problems including “binary option trading addiction”.

Many internet users will have become used to seeing the promotional advertisements of binary option platforms. YouTube is replete with videos with titles like ‘how I make 600$ a day”, or “how to make 10% profit in an hour” (these are actually conservative claims, many sites promise far higher returns), in which affluent-looking millennials explain how they have become financially independent using some simple trading rules that you, too, can learn in a few minutes. They often offer USD 50 or 100 of “free trading credit” to those opening new accounts. Perhaps as many as a hundred internet sites offer binary option trading in Indonesia, many marketing their products in the local language. 

These platforms can be accessed anywhere, by anyone with a computer, an internet connection, and a credit card, PayPal account or the like. The barrier to access is very low. The binary option platforms present themselves as offering the kind of democratic access to markets that goes with millennials’ desire to be in full control of their lives, without having to rely on banks, brokers, financial advisors or other intermediaries. The platforms claim that:

• No prior experience is needed to be able to operate in binary options platform or trade with binary options. It is easy to become a trader and earn extra income.
• Anyone can trade. Some platforms allow new accounts to be opened with as little as US 5, although the common range is US$25 to USD 100.
• Trade is direct, without having to pass through, or pay commission to, a broker.
• People can trade directly on their mobile phone, without downloading any software. 
• Binary options are much easier to trade than the traditional products of commodity, foreign exchange or stock markets.
• Remarkably high returns are a possibility, both in rising and in falling markets. And traders know in advance what will be the pay-out on their investment if they make the right choice.
• Different expiry times are available, from 30 seconds to 1 year. So traders can chose the time frame on which they want to focus.
• People can trade in a wide varieties of assets which includes commodities, currencies, stocks and indices.
• The risk involved in trading binary options is fixed: people cannot lose more than what they want to put at risk.

Take these claims with a pinch of salt! While the instrument itself certainly has its risk but also its positive sides, the over-the-counter platforms on which most binary options are offered do not offer a fair deal to investors.

A Brief History on Binary Option

Binary options trading have been in existence for quite some time now, but came to the limelight only after 2008, when the Chicago Board Options Exchange (CBOE) introduced binary options as a tradable asset, beside its mainstream foreign exchange and the stock products. Contrary to most of the binary options trading until then, CBOE offered a neutral platform; the typical over-the-counter binary option trading (still the main form outside the USA) has the retail client trading against the platform itself, which obviously gives the platform operators an incentive to somehow scam the client (contrary to an exchange, these platforms can only make money if the clients lose money).

Since then, the growth of binary options has been explosive, to a large extent driven by the growth in internet access. With the internet, it has become easier than ever to follow and track financial markets. And it has also become easy for retail investors to place trades directly, without passing through brokers (but note that when trading in binary options in licensed futures exchanges, retail investors still are managed under the umbrella of brokers, even if they input their trades themselves through their mobile phones).

While binary option platforms promote them as a way for the “common man” to become involved in the modern financial markets, many regulators have taken a bleaker view. In July 2018, the European Securities and Markets Authority prohibited the marketing, distribution and sale of most binary options to retail investors in the European Union (many binary option platforms with business addresses in the EU continued marketing the products to international users). 

Some binary options were excluded from this ban, namely a) binary options with a time frame of at least 90 days which are fully hedged by the provider of the option and b) binary options with a final net payout that is higher than the initial investment (i.e., the investor does not risk his capital, but only part of the return on capital).  

In fact, many of the problems of binary options are linked to the platforms, rather than to the products themselves. Many binary option providers are fraudulent, either outright stealing the investments of their clients, or use software that manipulates prices to ensure clients lose their money. Some may abuse the credit card and ID data that they collect from their clients.

Many claim to be regulated, but in the countries they are regulated effective regulation is largely absent; so, clients’ money is not normally kept safe (as would be the case for people trading in regulated exchanges), and there are no controls over the company’s business practices. Even if they are not overtly fraudulent, the binary option prices offered on the platforms are often very skewed, with a 55%+ chance for the trader to lose money (on regular futures and options market, theses skews are very small). Not surprisingly, most people who start binary trading on these unregulated platforms rapidly lose all of their money.

In 2017, the FBI estimated that binary options fraudsters steal USS 10 billion per year from victims around the world. That year, French prosecutors estimated that French citizens had been defrauded out of 4 billion Euro in the previous six years in binary option and foreign exchange trading scams. In Europe, binary options fraud complaints constitute as much as a quarter of all fraud complaints received by regulators and the police. As the FBI says on its Facebook page, “the perpetrators behind many of the binary options websites, primarily criminals located overseas, are only interested in one thing – taking your money.”

How should regulators and the legitimate financial industry act in the face of the realities of the binary options market? They share an interest in educating the public: fraudulent internet trading not only costs consumers massive amounts of money, but also tarnishes the reputation of legitimate financial investments, like in commodity exchanges. But should a regulator permit a commodity exchange to provide binary options? 

As noted above, the EU has taken the view that at least for the time being, it is better to almost completely prohibit the use of binary options by retail investors. But the US has taken a different view. Binary options are offered on regulated exchanges like the CBOE, the American Stock Exchange (AMEX) or the North American Derivatives Exchange (Nadex), and retail investors can access the markets through regulated brokers. Any trade of binary options outside of this regulated framework is illegal.

Binary options are very actively marketed in Indonesia by a large number of internet-based trading platforms, with even the promotional videos available in Bahasa Indonesia, and with a large presence on Indonesian social media. By and large, these platforms are not regulated, and the likelihood of Indonesian retail investors getting a fair detail is very small.

Completely banning binary options, like the EU has done, is unlikely to stop retail investors from continuing trading through internet platforms (for example, in Belgium, binary options trading was banned in 2016 and the regulator issued over a hundred warnings; despite this, reported frauds in 2017 were 45% higher than in 2016). 

To stop this fraud as soon as possible, one could adopt the US model: provide an environment for trading binary options in which investors’ money is protected and option pricing is fair and transparent, while closing down all the avenues for off-exchange trading. An Indonesian exchange offering binary options can offer investors a legitimate outlet for their desire to trade, with transparent prices and high levels of customer protection. Working together, the regulator and the exchange can then drive the unregulated binary option platforms out of the Indonesian market. 

(forex, trading, bursa berjangka, komoditi)