binary options

Response to ESMA Call on evidence on Binary OptionsDear Sir,

This is binaryoptions.com’s response to ESMA call on evidence on Binary Options

This contribution is solely focused on binary options and my definitive book on the subject, ‘Binary Options: Fixed Odds Financial Bets’ might suggest I am an expert on the subject. I own and used to actively operate the website www.binaryoptions.com on which I persistently denounced the activities of unscrupulous operators.

Before I address the question ‘I’ outlined in the ‘Questions’ section I wish to pass comment on some of the assertions the ESMA document makes in section 1.6. concerning the ‘….main features of BOs and the way in which they have been distributed, marketed or sold across the EU….’.

Your first bullet point states that “Retail investors are exposed to very high levels of risk and intrinsic negative expected returns….”.

Re: “….very high levels of risk…”:

  1. If one buys a binary call option or a binary put option one pays out a premium. Like conventional traded options this amount is known prior to executing the trade. These ‘very high levels of risk’ would then equally apply to conventional options as to binary options.
  2. If one writes a binary option, whether call or put, then yet again the ‘investor’ knows the exact amount at risk. This is not the case with the writing of conventional options whereby the investor may be rendered bankrupt by an extreme movement in price of the underlying asset which has generated an unforeseen financial loss and a negative balance at the broker.

From my assertions in 1 & 2 it may well be considered that conventional options are by far a greater risk to retail clients than binary options as conventional options undoubtedly do expose those clients to a higher level of risk than binary options.

Re: “….intrinsic negative expected returns….”:

  1. All financial assets have a selling price and a buying price which are generated by the market-makers. If one assumes that the value of the asset is the arithmetic mean of the selling and buying price then the retail investor will be subject to a negative expected return as they will be buying above the asset’s value and selling below the asset’s value. This is a feature of all markets therefore the ‘intrinsic negative expected return’ is not confined to binary options solely, but all markets, whether equity, bonds, commodities, futures, conventional options, etc..
  2. Whether the retail investor is subject to ‘very high levels of….intrinsic negative expected returns’ is a function of how wide the bid/ask spread should in fact be. The most commonly traded binary options are the ‘Over’ and ‘Under’ which are the at-the-money (ATM) binary call and binary put. A feature of the ATM binary option with an extremely short time to expiry is that the delta can rise to absolute infinity, in contrast to an equity, bond, FX or future that always has a delta of 1. The maximum delta of a conventional option is absolute 1. A short term ATM binary option has the highest gearing of any financial asset and therefore the market-maker is justified in building in a wider bid/ask spread. The justifiable width of the Bid/Ask spread is dependent on the number of active clients trading both ways so the justifiable bid/ask spread will be different for each operator.

The above ESMA assertion goes on to state that in the face of the “…very high levels of risk and intrinsic negative expected returns….” binary options do not provide “….compensating benefits (in contrast with, for example, vanilla options that are often suited to provide hedging functions).” The vast majority of volume traded on financial markets (including “vanilla options” that I refer to as ‘conventional options) is speculative by nature so the ‘compensating’ factor is spurious. Yet should it be considered important one only needs to look at Industry Loss Warranties (ILW) traded on the Insurance-Linked Securities market. An ILW is a fixed return option, i.e. a binary option, used by insurance companies to hedge their exposure to extreme weather events, etc.. Indeed most home/car owners have fixed return options to hedge against fire/accident damage. Maybe ESMA would like to instruct insurance companies to offer conventional options to house owners and their like?

The next ESMA bullet point offers:

“The short duration of trades in combination with the extreme pay-off distribution increases the exposure to losses and raises the risk of addictive behaviour. Indeed, retail investors in BOs often place many repeated trades, making it increasingly likely that they will lose on a cumulative basis. This holds for BOs of any variety.”

It also holds for casino games such as roulette and fixed odds betting on sporting events. In fact, the above ESMA statement might in itself suggest that short-term binary options constitute gambling and should be regulated by the gambling commissions.

The next ESMA bullet point asserts:

“The complexity of these products [binary options] and a lack of transparent information at point of sale, which limits the ability of retail investors to understand the risks underlying these products.

Re: “The complexity of these products….”. This is nonsense as ESMA well knows. The reason that ‘Over/Under’ trades are so popular is because they are so simple!

Re: “….lack of transparent information at point of sale….”. Lack of what information exactly?

Re: “….limits the ability of retail investors to understand the risks underlying these products.” Binary options are NOT margined products therefore it is questionable that there is one binary options trader that does not understand the risk.

The final bullet point asserts:

“The use of aggressive marketing techniques, including the offer of incentives to clients to encourage trading in these products.”

This bullet point is now the crux of the matter. The aggressive marketing has been an utter disgrace, only matched by the regulators impotent response to the problem. The FBI have now taken on the responsibility of dealing with these unscrupulous operators, but what a great pity it is that the European regulators have lacked the teeth to snuff out these operators.

The below issues are what the regulators should be addressing:

  • cold calling, then subsequent repeat calling
  • the bullying of clients to put in more cash
  • the straightforward refusal of these scumbag businesses to repatriate client’s funds
  • the lying about where the business is based
  • the number of aliases adopted by principals…..

…..the list is endless.

But probably the worst fault lies with the regulators who deemed that these one minute duration Over/Unders actually constitute ‘investment’.

Under section 6 of the ESMA ‘Call for evidence, Question I asks:

“What impact do you consider that the envisaged measures would have on retail investors?”

Belgium already supplies the answer.

Belgium ‘banned’ the distribution of binary options within Belgium from 18th August 2016.

https://www.fsma.be/en/faq/fsma-regulation-governing-distribution-certain-derivative-financial-instruments-binary-options-0

Yet one year later the FSMA issued the following warning:

https://www.fsma.be/en/warnings/binary-options-fsma-warns-public-against-several-companies-operating-unlawfully-within

Leaprate (the financial eMagazine) published the following article on the ban:

https://www.leaprate.com/news/belgium-forex-and-binary-options-ban-backfiring-as-unregulated-brokers-filling-the-void/

Banning binary options will provide for:

  1. Rogue operators will operate from outside Europe where they are untouchable but still target Europeans.
  2. Retail traders that wish to use binary options and are using a legitimate (EU-based operator) (for the many reasons I advocate binaries are intrinsically safer than alternative instruments) will now be forced to use these rogue operators; their risk has been increased not reduced.
  3. Legitimate operators may now consider they relocate outside Europe.
  4. Those legitimate operators are now being persecuted by ESMA’s inability to tackle the rogue operators meaningfully.

Summary

Binary options have been much maligned but at the end of the day they are just a relatively new financial instrument. They are not Saintly, they are not evil, they are just another form of option that happens to be traded in huge quantities in the interbank FX market yet are being treated as if they are the problem, not the rogue operators.

In many respects retail investors are safer trading binary options than trading  futures, CFDs, spreadbets or conventional options.

In many respects, the current situation mirrors the early days of online gambling but regulators took a positive approach to regulating online businesses and the sector has now gained credibility and the confidence of the public.

The bottom line is that every single financial instrument can be replicated by a structure of binary options. They can be equated to machine code; the ‘0’s and ‘1’s of software languages. They are here to stay, they are not going away. Regulators are paid to regulate, not brush awkward issues under the carpet which ultimately is what a ban comes to.

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