Binary options appear to be the hot new thing in the world of trading. If you browse a finance site or watch a trading video you will be assailed with ads and comments touting the huge potential of this financial product. But all is not as it seems. Let’s dig in with a binary options review.
What are Binary Options?
With traditional options, you are buying or selling a contract that is based on the movement of some underlying asset. For example, a stock option is essentially placing a bet that the underlying stock will increase or decrease in price a certain amount before the option expires. With binary options, that underlying asset can be almost anything: stocks, commodities, Forex, etc. Like stock options, you place a bet that the underlying asset will either go up or down X amount in a set period of time. The similarities end there.
So How are Binary Options Different?
Tens – if not hundreds – of thousands of pages have been written about traditional options strategies. That depth and complexity goes out the window with binary options; you are essentially betting on a coin toss. Here’s how it works:
- WHAT: You select the underlying asset on which you want to trade. Most brokers offer numerous choices (more on this in a moment).
- HOW MUCH: Choose how much capital you are “trading”.
- WHEN: Select the time frame you want to trade. These time frames are all brief – minutes or hours. Compare that to stock options, the shortest of which are a week.
- PROFIT: Return on investment. This is fixed. 70% seems to be a common figure – you get a 70% return if you are correct, but lose the entirety of your invested capital if you are wrong.
So What’s the Problem?
Let’s go through the issues that correspond with each of the above points:
- WHAT: You aren’t “trading” anything. With a stock trade, you can (and should!) set stops, scale out, monitor volume and other market data, etc. None of that is possible with a binary options trade – you place your bet and then let it play out.
- HOW MUCH: Since you can’t set stops or scale out, you have no real ability to measure how much capital you should use for each trade.
- WHEN: The time frames are very short. Predicting where a stock will be in ten minutes is very difficult, but doing so without the ability to get out or otherwise modify your trade in that ten minute period is suicide.
- PROFIT: This is the most damning point: the risk to reward ratio is atrocious. If you win, you make 70%. If you lose, you are out 100% of your investment. At Bulls on Wall Street, we teach that you should have a minimum reward to risk ratio of 2:1, meaning if the trade goes against and you stand to lose $100, then if the trade goes your way you need to make at least $200. Any ratio below 2:1 puts the odds very much against you.
But There’s More…
All of the above, as bad as it, assumes one crucial fact: you trust the broker. Unfortunately, there is little evidence that you should. Binary Options “brokers” take the other side of the trade and some have been shown to use numerous techniques to ensure you lose. According to Yaron Zelekha, Israel’s former accountant-general:
There is a very wide information gap between the public and these players, and they are exploiting it to their advantage. The broker is not giving you a service like in a bank; he is personally betting against you. This is a flagrant conflict of interest, because you’re betting on something, and the person reporting the outcome wants you to lose.
The same Times of Israel article asserts the following:
A variety of ruses are used. The potential payout for a correct prediction is complex, opaque and calculated to minimize the company’s loss. If an asset is behaving in a predictable way — say, the price of copper starts to climb following an earthquake in Chile — the company will pull that asset from the online platform. At some binary options firms, the online platform is manipulated to provide false results that ensure the customer loses.
Binary Options Review Summary
In the best case scenario, binary options are a sour deal – it’s gambling, not trading. If you want to trade, there are far better vehicles than binary options. And if you want to gamble, you’d have better luck visiting Vegas, which is highly regulated and closely monitored.