Victor Yekimetsky on binary options

Binary options are nowadays widely recognized as one of the most accessible ways of getting introduced to financial markets. The pace of penetration in the retail segment has been truly overwhelming during the last 5-7 years, yet even though this type of instruments has undergone a noticeable shift of perception in both investors and market participants minds, we still see no finalized common opinion formed on the essence of that instrument.Let's try explaining and answering to ourselves what binaries actually are and that are their strong points.

Industry emergence. Following Fx on the way to regulation

The high popularity came at an initial reputational cost for the new asset class. One of the reasons for binaries rapidly gaining popularity was the lack of regulatory framework and industry standards, which ensured a strategic advantage over forex, derivatives other more complex markets in the eyes of emerging start-up brokers. The effort-efficiency of launching a binary brokerage attracted a vast number of undercapitalized market participants diluting the image of the service, leading to the incorrect perception of binary options being more like gambling and a scam rather than trading.

The sites [Binary option brokers] appeal to the same type of people who play poker online. But they somehow have an aura of being more respectable because they represent themselves as offering a form of investing. Don't kid yourself. These are gambling sites, pure and simple. It's probably just a matter of time before regulators move in on them.

Gordon Pape, "Don't Gamble on Binary Options" (Forbes), 27/07/2010

The gambling parallel was, unfortunately, widely exploited in promotional campaigns run by market participants. Balancing on the edge of two confronting definitions (gambling vs. trading instrument) has raised numerous discussions within the trading and expert community, both sides having their supporters. Gradually this debate fostered a view, which I personally find most reasonable, that primarily questioned not the essence of binaries, but mostly the suitability of any asset class to a particular individual or strategy. Since one of the meanings of gamble is taking risky action in the hope of a desired result or staking something on a contingency, pretty much any financial instrument may be considered as an object of gambling if approached without proper prudence.

Judging by this definition, a lot of what we do in daily life is gambling. Binary options are gambling much like other financial instruments, tangible or intangible.

"Are Binary Options a Form of Gambling?" (FinanceMagnates), 30/07/2014

Indeed, opening an overleveraged Fx position with a micro-account, opening a leveraged CFD position without stop-loss on a stock the trader does not have a profound knowledge about, going into a derivative while not building a real hedge does not seem getting any further from gambling in the common perception of that concept. You may have grasped that the common trait of the last 3 examples is poor risk management.

Let's be honest, any investment activity is gambling. Venture capitalists also gamble when they invest into start-ups, there is no guarantee that the company will survive let alone bloom.

"Are Binary Options a Form of Gambling?" (FinanceMagnates), 30/07/2014

Poor risk management usually originates either from the intended will to speculate with high risk or from the unsuitability of the instrument to the particular client, which in its turn comes from the lack of regulation in client assessment, informing and general education. And here again we return to the initial problem with binaries - the lack of regulation.

Fortunately, we already are seeing a retraction of this tendency towards a closer regulatory oversight, renowned financial market participants embracing the binary offer in their product range and traders exploiting the original strong qualities of binary contacts in their trading strategies. Cyprus CySEC was the first watchdog to officially start regulation of binary option brokers in 2012, while many of other EU jurisdictions kept viewing binaries as "game of chance" and directed requestors towards their local gambling regulatory bodies.

Things started changing fast in 2015. The year started with a landmark decision by Rotterdam court (Source) on the OptieClub case, where the Netherlands financial regulatory body (AMF) was forced to issue the first licence to a binary options broker. The watchdog had rejected the request earlier despite falling into the financial markets product definition under MiFID regulations and directed the broker to the Dutch Gambling commission. Similar news are coming from the UK where Her Majesty's Treasury issued a consultation paper considering regulating binary options as financial products.

The UK Government is consulting on proposals to treat binary options as a financial rather than a gambling product.

This would mean binary options would be regulated by us, the FCA, in line with practice across most of the EU, and no longer be regulated by the Gambling Commission.

UK FCA Official Statement, 26/05/2015

Both the Dutch court decision and UK initiative are indications on an impending paradigm shift that might open the gates for legitimisation of binary brokers seeking to get solid regulation in the EU market.

Essentially, binary options industry is following the same path the Forex markets started 15 years ago: starting as a newly emerging speculative market dominated by non-regulated participants, low client confidence and ambiguous image retail, Fx turned into a well-established industry, overseen by financial authorities in virtually all developed countries; it is now offered in the product range of numerous commercial banks. Binaries are now making the same journey towards regulation and transparency and seem to be doing it faster than Forex did in the past.

At Dukascopy we have been feeling the shift of attitude to binary options especially strongly as our decision to enter the binary market 2 years ago was being taken amidst reported reservations regarding the suitability of this service to a well-established and reputable broker. On the contrary, we saw a clear competitive advantage in the fact that binary trading will be offered by a Swiss-regulated bank via proprietary platforms. We believed that this should contribute to the diversification of the market, reinforce traders' security and offer an alternative to standard solutions thus ultimately improving client confidence to the entire market segment.

Binaries as simple, yet secure and useful financial instrument

Simplicity, straightforwardness and transparency are considered to be the key inherent traits of binaries. Absence of commissions, binary result (i.e. there exists only 2 outcomes), which implies possibility of capitalizing with maximum payout on minimal market movements; contract amounts as low as 1 USD and available short timeframes, sometimes less than a minute.

Despite the doubts of being proclaimed speculative, binary options should be advocated as possessing all the characteristics of a financial instrument that can be used to realize investment goals.

Binaries have particular attraction for investors whose strategies involve trading on economic news. News trading is a sophisticated investment activity that at minimum implies the following:

  • Knowing when news are out and in what countries;
  • Being capable to carry out technical and fundamental analysis to assess the news impact;
  • Picking a currency pair/pairs that are expected to be impacted;
  • Forecasting the needed duration of an option (e.g. 5 minutes or an hour) to avoid the interim noise volatility before and after the news is out;
  • Correctly and carefully placing a pending order and describing it.

Noise volatility (volatility spikes) is a real problem for news traders that can be successfully dealt with using binaries. Here is a real-life example that demonstrates the impact of volatility:

Example 1: ECB Minimum Bid Rate (act. 0.50%, exp. 0.50%, prev. 0.75%)

Date and Time: 02/05/2013 11:45 GMT

Pair: EUR/USD

ECB has reduced the base interest rate by 0.25%, which elicited a downward pressure on the EUR/USD. However, a trader who correctly interpreted the news might come across a noise volatility that could have resulted in interim losses on a spot position. Binary option would be more preferable in this situation.

Example 2: ECB Minimum Bid Rate (act. 0.50%, exp. 0.50%, prev. 0.75%)

Date and Time: 02/05/2013 11:45 GMT

Pair: EUR/USD

Unemployment claims came out significantly lower than expected. However, the investor who correctly predicted it and forecast downward movement of USD/JPY would face an unpleasant surprise when the pair hiked by 50+ pips. After the unexpected spike the pair abated as expected. An investor with short spot FX position could have been closed on margin cut or voluntarily closed the losing position. Binary option would again help the trader pass over the spike and gain on the correct forecast.

Binaries also feature a set of important qualities related to trading/execution risks management. First is the independence of market depth, which means technical absence of slippages. Second, predefined maximum profit and, most importantly, maximum loss make it impossible to lose more than the amount of the contract. The latter also implies impossibility of driving the account into negative equity even under market force majeure conditions like those observed during the CHF soar on January, 15th 2015 after the Swiss National Bank's surprise decision to abandon the EUR/CHF floor.

With all of the above features binary options are making another major step in turning markets more accessible to a retail trader, comparable to forex instruments going into electronic trading on retail platforms 2 decades ago.

Adding a unique touch to binaries in Dukascopy

Being a banking group with an considerable IT development expertise Dukascopy undertook the development of an in-house binary service and trading platforms (Web, iOS and Android), which ensured considerable flexibility and freedom compared to the common approach of going into a white-label with one of the major platform vendors, an approach that had become standard at that time.

Seeing binaries as a new area for us, we went for a conservative start with offering the classic yet most widespread Up/Down binaries on currency pairs. Our flexibility allowed us offering features that were and remain unique in the market even for that basic binary options type: fixed payouts with a default level of 90%, which still remains among the highest in the market, custom-set option durations of 1-60 minutes with 1 min discretion. To achieve total transparency of the price feed we are using the SWFX (Swiss Forex Marketplace) flux, i.e. the same quote source as Dukascopy's Fx/CFD trading platforms. Another valuable feature highly appreciated by technical traders are the fully-functional charts with over 180 indicators and drawing objects available in the Web Binary platform.

After the service was successfully launched for the clients of Dukascopy Group, binaries became available as a separate module in the Dukascopy White-Label partnership program.

This year we extended the instruments range with Daily Stock Options giving access to a session trading of over 1500 stocks from all over the world and Pair binaries on stock/index combinations. Unlike the conventional approach of offering a short fixed set of pair combinations, our traders can build their own compositions.

Many updates and new features are now in the pipeline. This includes further integration of our products, allowing automatic creation of new trading subaccounts and platform improvements. To harmonize the offerings available to Fx/CFD clients and binary traders we are now working on launching an equity bonus program for binary accounts. Finally, new binary instrument types, including the Touch binaries and their variations, are on the way. Again, as with Up/Down options, we intend to continue re-thinking conventional instruments while striving to add a unique element to our service.

All the above mentioned unique features of our binary options are fully available to the retail clients thanks to Dukascopy Europe. Binary options accounts with Dukascopy Europe are available for contract sizes from 1 USD and an initial deposit of 100 USD. I invite you to get your own experience of binary trading with us at www.dukascopy.eu

Victor Yekimetsky

Binary options trading project lead

Dukascopy Bank