binary options

CySEC Consultation Document

cysec consultation documentYet more good news for the retail investor from CySEC, the Cypriot financial services regulator. On the 14th December they issued a CySEC consultation paper regarding the transparency and operation of binary options providers. A number of key elements are at the core of the paper.

Underlying Asset

CySEC are clearly concerned with the lack of specification of the underlying asset and have chosen oil as their example. This is a good choice because many CIFs describe the asset as simply oil with no elucidation as to whether the asset price is tied to Brent, WTI, an amalgam of the two, or even that it refers to crude! This wishy-washy approach enables the more unscrupulous operators to post settlement prices in the ‘house’s favour as there is little chance of gainsaying the settlement price is wrong.

There is another reason that assets are not stipulated more accurately and that is that the domain of the traded price, e.g. ICE, CME, etc. will want their royalties for using that price. When the exchanges went electronic and the internet started to rear its head as a medium of trading the dissemination of prices became a bone of contention with the exchanges as they consider, probably quite rightly, that these prices are intellectual property. Initially the exchanges got a bit silly and tried to charge exorbitant rates which, of course, does not necessarily work in their favour as it offers the possibility of a rival exchange listing an identical product and undercutting them, with the obvious loss of trading fees.

Whatever the reason, CySEC tightening up on contract specifications is a good thing for the end-user.

Realtime Price Distribution

CySEC also takes issue with how often the prices are disseminated to the client with further requirements regarding the calculation of the prices if the price is an CySEC Consultation documentaverage of the bid and ask. This is yet again a huge plus for the retail trader as it yet again tightens controls on the provider offering dodgy prices.

But where CySEC is really going to shake up many operators is where they do not offer an accurate current asset price to the investor, especially when offering at-the-money calls and put, more commonly known as Over and Under. Many operators outline the fact that they are not offering accurate prices somewhere around the bottom of their T&Cs page, in other words it is not a great selling point. But this is a dumb attitude. If the first client buys an Over then the provider will show a lower than the real asset price as a form of risk management. The savvy trader would see this and buy the Under as it is now in-the-money. The savvy trader gives themselves a better chance of winning while the provider has hedged away their risk. Happy days! The providers should be pushing this feature, not hiding it.

Settlement Prices

Operators will now have to provide detail as to how the settlement price is arrived at. About time too.

Cancellation Option

An issue that is likely to be pretty controversial is the ability of the client to cancel the trade up to five seconds after it has been placed. This is anathema to markets in general and is likely to result in even worse returns offered to all the clients.

Options cost money. If the provider is forced to sell to the customer an option for nothing then the provider will look to recoup that cost elsewhere. If a client were to use this free option then they shouldn’t be trading.

Yet there is another important issue at stake here. No doubt CySEC would want their CIFs to manage their portfolios of options in a proficient manner, in particular, immediately changing the underlying asset price to coerce the next trader to take a position in the direction that decreases the ‘book’s’ risk. Yet how does the provider do this if the provider does not know whether the trade is firm or not. The upshot is that the provider could hedge a position that they do not have should the client cancel.

This is not a good idea.

Option Duration

It would appear that binary options suffer from discrimination in terms of the length of time the option is held. Apparently binary options of one minute duration or less do not conform to the notion of an investment. So a binary option with duration of ninety seconds is an investment but a binary option of thirty seconds less is not.

Firstly one might ask how this duration of sixty seconds or less was arrived at? The Japanese FSA have come out with a minimum duration of one hour. Yet again, why one hour? It seems these time scales are arbitrary numbers plucked out of the ether and one can see regulatory arbitrage becoming a major issue to the advance of the market.

Discrimination though? Consider High Frequency Trading (HFT) algos. These computer-generated trading apps are designed to trade n and out of the market in sub-second time scales. HFTs the world over are considered investment vehicles and now dominate the global trading environment. Why one might ask is it an investment to dive in and out of the market within the time scale of one second whereas a binary option must have a rolling duration of sixty seconds?

One man’s investment is another man’s gamble.

CySEC Consultation Paper Summary

Any imposition by a regulator to enforce existing rules and bring in new rules that are beneficial to the client by and large are welcome. That CySEC is clearly bent on cleaning up the binary options industry is good news, especially with contract specs and asset price transparency. Enforcing arbitrary time scales? No. Forcing providers to give the client free options is a marketing gimmick more in keeping with the Paddy

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