Binary options is a form of financial trading which will require traders to open trading accounts with brokers. Unlike the forex or stock market where assets are listed with a clear bid price and ask price, with brokers being compensated by the difference between the bid and ask prices (the spread), the binary options market has no such distinction. The question therefore is: how do binary options brokers make money?
It has become pertinent to address this question as I am continuously bombarded with questions about whether brokers in the binary options market tamper with the pricing of the assets in order to skew the market in their favour, and whether the trader is thus trading against the broker and vice versa. A binary options broker make money in a variety of ways, otherwise they would have been out of business a long time ago.
One way that a binary options broker makes money is by the pricing structure that prevails in the binary options market. There are many theories about how a binary options broker receives the pricing they give to traders. A binary options broker will generally get their pricing from one or multiple liquidity providers in the market. But are the prices given to traders the same as are received from the liquidity providers? It is very likely that traders in the binary options market are offered slightly marked-up prices for any assets that they want to trade in the market.
Whenever a trader wants to purchase an asset, the pricing of the asset is displayed. For some brokers, the traders are shown the expected payouts in monetary terms as opposed to percentage payout. A portion of what is not paid out is actually the commission earned by the broker for this trade. For some other brokers, there actual amount deducted from the trader’s account when a trade is initiated includes the broker’s commission. This is one way that binary options brokers make their money.
The second way binary options brokers make their money is from the normal trading activity that goes on in the binary options market on a day to day basis. Have you ever stopped to ask yourself who makes all the money from the losing trades in the binary options market? This short calculation is about to blow your mind away.
Let us take for example, that a binary option brokerage company named CrasBCD has 200 clients who decide to trade the Up/Down trade on the EURUSD. 100 of those clients bet that the EURUSD will go up by one hour, and the other 100 bet that the EURUSD will go down in one hour. Each trader bets $100 for this trade, putting $20,000 in the market pool on this trade. The payout for the trade is 80% for a winning trade, without any loss return (i.e. no money returned on a losing trade).
In one hour, the EUR/USD actually ends the trade higher. 100 traders on the UP end of the trade are paid $80 as well as the $100 they initially invested in the trade, for a total of $180 per trader or $18,000 total. The 100 traders on the DOWN end of the trade get zero. They lose everything invested on the trade. But remember that $20,000 was in the market pool. So who walks away with the $2,000 left in the pool after the winning traders have been paid? The binary options brokers!
When you consider that this is for a $100 trade volume, for an expiry as short as one hour, can you even imagine how much money the binary options brokers would make if they had 1,000 clients trading the same period? This pushes the revenue from ONE SINGLE TRADE to $20,000. Now imagine that 10 of such trades are done on a daily basis, 5 days a week, 4 weeks a month? This is a staggering four million dollars in pure profit.
The problem is, the example we just gave assumes a perfect balance. If we had 180 traders on the UP side and only 20 traders on the DOWN side, then the broker has a problem. This is where the drama starts.
Two things happen:
a) The brokers are able to make up the numbers from traders who trade the highly speculative trades where the trader has a 1 in 10 chance of winning. Run bets such as those which pay the trader for correctly guessing that the last digit in a price quote will be a particular number from 0-9 in the next 5 ticks are a sure weapon for equalizing such deficits.
b) Then we have trades like the 60 second trades where half a pip can make the difference between winning and losing. I have seen a live platform where a trade was pushed from profit position to loss position in the very last second of the trade. This is why the 60 second trade is not my favourite trade.
How does a binary options brokers make money? You have just seen it for yourself.