Binary options regulation and why you need to know this

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What You Need To Know About Binary Options Outside the U.S

Binary options let traders profit from price fluctuations in multiple global markets but it’s important to understand the risks and rewards of these controversial and often-misunderstood financial instruments. Binary options bear little resemblance to traditional options, featuring different payouts, fees, and risks, as well as a unique liquidity structure and investment process.

Binary options traded outside the U.S. are also structured differently than those available on U.S. exchanges. They offer a viable alternative when speculating or hedging but only if the trader fully understands the two potential and opposing outcomes. The Financial Industry Regulatory Authority (FINRA) summed up regulator skepticism about these exotic instruments, advising investors “to be particularly wary of non-U.S. companies that offer binary options trading platforms. These include trading applications with names that often imply an easy path to riches.” 

What Are Binary Options?

Binary options are deceptively simple to understand, making them a popular choice for low-skilled traders. The most commonly traded instrument is a high-low or fixed-return option that provides access to stocks, indices, commodities and foreign exchange. These options have a clearly stated expiration date, time and strike price. If a trader wagers correctly on the market’s direction and price at the time of expiration, he or she is paid a fixed return regardless of how much the instrument has moved since the transaction, while an incorrect wager loses the original investment.

The binary options trader buys a call when bullish on a stock, index, commodity or currency pair, or a put on those instruments when bearish. For a call to make money, the market must trade above the strike price at the expiration time. For a put to make money, the market must trade below the strike price at the expiration time. The strike price, expiration date, payout, and risk are disclosed by the broker when the trade is first established. For most high-low binary options traded outside the U.S., the strike price is the current price or rate of the underlying financial product. Therefore, the trader is wagering whether the price on the expiration date will be higher or lower than the current price.

Binary Options Outside the US

Foreign Versus U.S. Binary Options

Non-U.S. binary options typically have a fixed payout and risk, and are offered by individual brokers rather than directly on an exchange. These brokers profit on the difference between what they pay out on winning trades and what they collect on losing trades. While there are exceptions, these instruments are supposed to be held until expiration in an “all or nothing” payout structure. Foreign brokers are not legally allowed to solicit U.S. residents unless registered with a U.S. regulatory body such as the Securities and Exchange Commission (SEC) or Commodities Futures Trading Commission (CFTC).

The Chicago Board Options Exchange (CBOE) began listing binary options for U.S. residents in 2008.   The SEC regulates the CBOE, which offers investors increased protection compared to over-the-counter markets. Chicago-based Nadex also runs a binary options exchange for U.S. residents, subject to oversight by the CFTC. These options can be traded at any time, with the rate fluctuating between one and 100, based on the current probability of the position finishing in or out of the money. There is full transparency at all times and the trader can take the profit or loss they see on their screen prior to expiration. They can also enter as the rate fluctuates, taking advantage of varying risk-to-reward scenarios, or hold until expiration and close the position with the maximum gain or loss documented at the time of entry. Each trade requires a willing buyer and seller because U.S. binary options trade through an exchange, which makes money through a fee that matches counter-parties.

High-Low Binary Option Example

Your analysis indicates the Standard & Poor’s 500 index will rally for the rest of the trading day and you to buy an index call option. It’s currently trading at 1,800 so you’re wagering the index’s price at expiration will be above that number. Since binary options are available for many time frames—from minutes to months away—you choose an expiration time or date that supports your analysis. You choose an option that expires in 30 minutes, paying out 70% plus your original stake if the S&P 500 is above 1,800 at that time or you lose the entire stake if the S&P 500 is below 1,800. Minimum and maximum investments vary from broker to broker.

Say you invest $100 in the call that expires in 30 minutes. The S&P 500 price at expiration determines whether you make or lose money. The price at expiration may be the last quoted price, or the (bid + ask)/2. Each binary options broker outlines their own expiration price rules. In this case, assume the last quote on the S&P 500 before expiration was 1,802. Therefore, you make a $70 profit (or 70% of $100) and maintain your original $100 investment. If the price finished below 1,800, you would lose your original $100 investment. If the price expires exactly on the strike price, it is common for the trader to receive her/his money back with no profit or loss, although brokers may have different rules. The profit and/or original investment is automatically added to the trader’s account when the position is closed.

Other Types of Binary Options

The example above is for a typical high-low binary option—the most common type of binary option—outside the U.S. International brokers will typically offer several other types of binaries as well. These include “one-touch” options, where the traded instrument needs to touch the strike price just once before expiration to make money. There is a target above and below the current price, so traders can pick which target they believe will be hit before the expiration date/time. Meanwhile, a “range” binary option allows traders to select a price range the asset will trade within until expiration. A payout is received if price stays within the range, while the investment is lost if it exits the range.

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As competition in the binary options space heats up, brokers are offering additional products that boast 50% to 500% payouts. While product structures and requirements may change, risk and reward is always known at the trade’s outset, allowing the trader to potentially make more on a position than they lose. Of course, an option offering a 500% payout will be structured in such a way that the probability of winning the payout is very low.

Unlike their U.S. counterparts, some foreign brokers allow traders to exit positions before expiration, but most do not. Exiting a trade before expiration typically results in a lower payout (specified by broker) or small loss, but the trader won’t lose his or her entire investment.

The Upside and Downside

Risk and reward are known in advance, offering a major advantage. There are only two outcomes: Win a fixed amount or lose a fixed amount, and there are generally no commissions or fees. They’re simple to use and there’s only one decision to make: Is the underlying asset going up or down? In addition, there are also no liquidity concerns because the trader doesn’t own the underlying asset and brokers can offer innumerable strike prices and expiration times/dates, which is an attractive feature. The trader can also access multiple asset classes anytime a market is open somewhere in the world.

On the downside, the reward is always less than the risk when playing high-low binary options. As a result, the trader must be right a high percentage of the time to cover inevitable losses. While payout and risk will fluctuate from broker to broker and instrument to instrument, one thing remains constant: Losing trades will cost the trader more than she/he can make on winning trades. Other types of binary options may provide payouts where the reward is potentially greater than the risk but the percentage of winning trades will be lower.

Binary Options Regulation

While binary trading has become extremely popular during the last decade, many traders are still hesitant to make investments in this market as a result of fears relating to binary options regulation and the security encompassing options trading. This elevated feeling of concern is to some extent due to the level of trust that traders have with regards to the financial markets.

Indeed, there have been a number of binary option scams that have tripped up a large number of traders and left them with a sour feeling in their mouth. Even if a broker is well known and appears to have a strong online reputation, traders are naturally concerned about the legal protections afforded to them in a worst case scenario event.

At the trading club, our members regularly keep up to date with the most important regulatory changes in the industry from broker rules to trader rights.

EU Regulation

At present, one of the preferred locations for binary options brokers to become regulated for EU coverage is in the Republic of Cyprus. Due to the fact that Cyprus is among the lesser developed financial systems in Europe, many people have a tendency to think of Cyprus as a location which has with little or no financial regulation system in place. To these individuals, this is the primary reason as to why a binary options broker would base their operation in Cyprus, in an effort to steer clear of regulation. In truth, one of the main reasons as to why many brokers choose Cyprus is lower tax rates. In Cyprus, the tax rate on corporate profits is 10%. Compare this to the United Kingdom rate of 24% and the reasoning for selecting Cyprus becomes even more clear.

For even more insight, consider the United States, where tax rates are even higher than they are in the United Kingdom. US-based companies can be taxed at rates up to 35%. When you take into consideration the simple fact that the vast majority of the binary options market is found in Europe, it seems to make sense that brokers would choose to be based in Cyprus. Furthermore, many traders notice that most binary options brokers are not willing to accept traders who reside in the United States. In doing this, they are able to avoid being taxed by US tax regulators.

What is Cysec?

CySEC (Cyprus Securities and Exchange Commission) was set up under the Securities and Exchange Commission Law. The objective of this supervisory authority is to make certain that binary options regulations are in place in order to safeguard investors as they participate in securities and binary options trading. The mission of the CySEC is to issue licenses to qualifying investment firms, brokers and other agencies within the investment market. CySEC is also in charge of removing a firm’s operating license in the event of misconduct.

CySEC additionally oversees the operations and financial dealings of the Cyprus Stock Exchange, along with those of other participants in the investment market. The commission works to make sure that the all agencies that fall under its supervision are following the laws. When necessary, CySEC will investigate trader reports to make certain that binary options traders are protected and will also investigate on the part of regulatory agencies in other countries. Brokers that are found not to be in compliance with the required laws are subjected to disciplinary measures and can lose their license.

Cysec Rules

Under CySEC rules, any binary option broker is required to hold all investors funds inside of a trust account. What this means is that the funds that a trader deposits with a regulated binary options broker are held independently from the brokers’ business funds.

As a result, traders can be confident that their funds are protected from scams, theft or the negative effects of bankruptcy. CySEC binary options regulations do require licensed brokers to secure a third-party who will work to keep them accountable. This helps to make certain that brokers are holding to the required laws and regulations.

In accordance with CySEC requirements, licensed binary options brokers are obligated to exercise the maximum level of openness by allowing public and regulative authorities to look into their operations. This is extremely important because it helps to protect traders from dishonest brokers and it requires brokers to implement best business practices. Last but not least, binary options brokers that are regulated by CySEC are instructed to offer legitimate assets and to hold to industry requirements for the trading of binary options. In contrast, it is not uncommon for unregulated brokers to offer illegitimate assets for trading.

While some might claim that financial regulation standards in countries such as the United Kingdom and Germany are better than those of Cyprus, this is often due to the fact that many people have no clear comprehension of how the Eurozone marketplace functions. As part of the regulatory framework of the financial trading markets within the Eurozone, the EU parliament has put forth the Markets in Financial Instruments Directive, or MiFID. The MiFID was designed to enhance consumer security and to help combine the different financial markets into one single market. It is important to note that Cyprus is in complete compliance of MiFID guidelines.

MiFID went into effect in November of 2007 and since that time has been the foundation of the European Commission’s Financial Services Action Plan. Commission actions drastically changed the way in which EU financial services market segments operated. The MiFID set forth measures that transformed and improved upon the organization and operations of investment firms, assisting with cross-border binary options trading while creating tactical opportunities. CySEC closely monitors binary option brokers to ensure that they remain in compliance with MiFID.

Why is a Cysec Regulated Broker Safe?

In regards to legal protections against scam investment companies, Cyprus actually maintains higher standards in fiduciary responsibilities than the United Kingdom, which does not yet operate in complete compliance of the MiFID. The OTC markets have always primarily been self-regulated, which is why there is very minimal binary options regulation in existence. Only recently has the regulatory platform to manage binary options been drafted out. Cyprus was among the first Eurozone members to have adopted legal classification for binary options. With this legal definition, regulatory authorities such as CySEC have become empowered to take action under the financial regulatory structure.

Traders might be astonished to discover that binary options are actually not classified as “financial options” under the United Kingdom Financial Services Act. As an alternative, traders are likely find UK-based binary options brokers being regulated by the UK Gaming Commission which classifies binary options trades as “bets”. In the United Kingdom, betting debts cannot be enforced within the courts, as they are referred to as “debts of honour”. Visualize a scenario where a trader attempts to file suit against a UK-based binary options broker for this type of debt.

Some binary options brokers, after receiving their license to be regulated by CySEC in Cyprus, will go on to register in other countries such as the United Kingdom or Germany. Some regulated brokers have taken their CySEC license and registered with BaFIN in France, or the FCA in this United Kingdom. For example, IQ Option has a CySec licence as well as a Consob one from the Italian regulators. These actions only service to create an added position of registration. A brokerage is not required to register with multiple EU regulators in order to conduct business throughout the EU. Even so, it is always important for traders to verify that their chosen binary option brokers do hold a license and that the license remains valid.

Things Every Trader Should Know About Binary Options

If you are looking for an article about trading techniques or tactics this is not it. This is an article unveiling many of the truths, or half truths, surrounding the binary options industry. Am I talking about scams, affiliate marketers, tipsters or gurus? No, I am talking about the industry itself, where it came from, where it is, where it is going and why you need to know. The industry exists on the internet, largely outside the lines of international boundaries and utilizing the digital marketplace in a way that allows average traders access that would otherwise not be possible. Some of the benefits of binary options includes simplified trading, fixed pricing/returns, no need for margin accounts and access to assets otherwise prohibited by account size or type. The main reason binary is so popular is because of this unprecedented access, easy to trade format and fixed returns.

Where Did Binary Options Come From?

Binary options have always existed. They originated as a gentleman’s bet between market participants and existed on the sidelines of legitimate trading. That is until the CFTC, along with the SEC, began to change the rules and allow for over-the-counter binary options trading. This change to rule, although misguidedly, led to the rise of the modern binary options industry. The thing is, 99.9% of binary options brokers on the internet today are not what the CFTC intended, are not CFTC compliant and therefore not acceptable for US citizens. This however did not stop many brokers from building platforms and offering what are now termed European or CySEC style binary options. Now there are several categories of binary including CFTC, CySEC, Japan FSA, “off shore” and few others. This means that there are a number of options, no pun intended, for traders to choose from.

Binary Options Regulation Is Not Regular

As I mentioned above the US CFTC, Commodities and Futures Trading Commission, is in charge of the rules and regulations surrounding the trading of binary options in the US. They have set forth a number of regulations that resulted in a unique form of binary trading known as 0-100 binary. These options have different strike prices and can be bought or sold at any time. NADEX and Cantor Exchange are the two most notable sources of binary in the US. For many years everything else was simply referred to as “off shore” binary. Off-shore binary is based on spot prices, you trade or bet the amount of your choosing on whether or not the asset will move higher or lower from the current, or “spot” price. These brokers were set up in banking havens like the Virgin Islands, The Seychelles and on Cyprus, where the first true non-US binary regulation took place. CySEC, the Cyprus Securities and Exchange Commission, began to regulate binary in 2020 and has made some real progress in terms of standardizing broker operations and ensuring the safety of trader money. Since then Japan has also entered the fray enforcing a style of trading that encompasses parts of both styles. To this day there is still no international standard or regulation for binary so traders often must choose to trade at their own risk with an unapproved or unregulated broker.

What Is The Difference Between A Platform and A Binary Options Broker?

A binary options platform is the software that enables trading. For the user it is what appears on the screen when you open your account to trade. The thing to keep in mind that the platform is not neccesarily the same thing as a broker. There are several white label platforms on the market that a business can buy or subscribe to in order to set up a binary options brokerage. SpotOption is perhaps the most well known of the white label platforms. There are several hundred binary option brands based on the SpotOption or Spot2 platforms. These brokers also share a central cashier system as well as other features. Some notable brokers using this platform are Banc De Binary, OptionTrade and Titantrade.

Now, there is also a big big difference between brokers, and not just between different regulatory types although that is a big difference as well. As mentioned previously US CFTC options at NADEX are based on the 0-100 method whereas CySEC options are based on the spot price. The thing is, not all CySEC, or CySEC style brokers, use the same math to determine the “spot” price. It is based on their own formulas and includes risk mitigating factors to help the broker maintain positive cash flow. In the end each CySEC style broker sells options at the rate at which they “feel comfortable selling options”, not the true market price. On top of that they do not all have the same assets, the same expiry types or even the same options. All will have a form of high/low, over/under or call/put trading and most will offer something else that may include range, boundary, one touch or speed trading. Regulation only adds to the confusion instead of helping it. A broker or platform regulated in one arena may not be regulated in another in which operates.

The Bottom Line

The bottom line is that binary options are here to stay. The state of regulation only proves it, if it were a passing fad then the practice would get squashed and fade away. Of course, there is still a long way to go before there is an international standard which will allow binary to be traded like forex but we are on the way. Until then education is the key for successful trading. Not only do you have to be a savvy trader you must know everything you can about binary option regulation, the platforms, the brokers and how it all relates to you and where you live. Choosing the wrong broker is more than having the right assets or expiry available, it means choosing the right broker and platform for you and where you live.

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  • Binomo
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