Binary Options Trading or Gambling

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Common Misconceptions About Binary Options

There are many misconceptions about binary options, so it is important that traders understand exactly what they are–and are not–in order to use them effectively.

Here’s a look at some of the more common misconceptions.

Binary Options are Just Gambling

At least on the surface, binary options are structured just like a $100 bet on a football game: You buy the team you like or you sell the team you don’t. A binary is just a simple yes/no trade. The yes trade means you agree with the binary statement—that the market will reach a certain level before expiration, for example—while the no trade means you disagree. The pricing of the binary is between zero and 100 throughout the lifetime of the option.

Unlike football where the underdog will receive odds, the binary has a multitude of strike prices that have a variety of fixed odds.

If you buy a binary priced at 20, there is a low probability of it paying off. Your cost is $20, while your potential profit is $80.

If you sell a binary priced at 20, then there’s a high probability of it paying off. But your cost is $80, while your potential profit is $20.

You can trade binaries on stocks, futures, foreign currency and ETFs as long term investment and or flip them as a speculative short term trade.

Binaries can also be used as a hedge just like standard put options. The difference with binaries is that your potential loss is limited, you can have a very short time horizon and your payout is either all or nothing.

Binary Options May Be Bought But Not Sold

As you look at the various strike levels of a particular binary option, you’ll see the similarity to call options. As a binary buyer, you’re bullish about the underlying market. The binary at expiration is valued at $100 if underlying market finishes above the strike so the various strike levels will draw similarity to in the money, at the money and out of the money call options as to the relationship of the underlying to binary strike. The at the money binary will be priced around 50 and the pricing is limited to the trading range of zero to 100.

You will not find the binary option chain for the puts. To sell a binary you are taking the opposite view, you’re bearish the underlying market and think it will finish at or below the strike at expiration. So to sell a binary, you go short the binary at the trade price.

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Remember that the binary contract is fully collateralized.

AUD/USD >.9140 (3PM) traded at 28

Binary Buyer: is long at 28 trade price and his cost is $28 per contract.

Binary Seller: is short at 28 trade price and his cost is $72 per contract.

Fully Collateralized: buyer cost $28 + seller cost $72 = $100 Expiration payout

You Are Required to Hold Until Expiration

Binary options are not buy and hold contracts until expiration. At any point prior to the expiration, the binary position can be offset to cut your trading losses or lock in an early trading profit. When you initiate the binary position, your initial trade cost is your maximum exposure, so you’re either long or short the binary at the binary trade price. In a long binary position, you want the price to rally to 100, while in a short binary position you want the binary pricing to sell off to zero.

Binary Options are Not Regulated

Many binary options that are traded over the counter outside of the US are not regulated.

In the US, there are three exchanges, regulated by the CFTC, offering binary options trading, Nadex being the first and largest for retail traders.

Binary Options are Not Transparent

If you are trading binary options on a regulated exchange, you will be provided accurate and up to date time and sales data on all bids, offers and trades throughout the trading session. That’s because the exchange is simply matching buyers and sellers on every trade.

Binary Options Requires Enormous Capital

All binary options are priced between $0 and $100 and the minimum amount to open an account with Nadex is $250. Since you are never trading on margin, your account always needs to have sufficient funds to cover the initial cost of the trade plus trading fees.

With binary options, the maximum risk and the potential profit are clearly defined to the terms of the trade assuming a favorable expiration payout. To trade on Nadex, the initial cost is a fraction of the leverage markets on which the Nadex products are based.

Binary Options – Trading or Gambling?

If you’re still unsure whether binary options is more like gambling you should read this article.

This guest article was written by Simon Klein who is a professional trader with over 10 years of trading experience. Simon has a passion for trading and loves to train and coach others – whether a complete beginner or an experienced trader. He is also the founder of TradeSmart4x.com.

Binary Options are a hot topic at the moment. There is a lot of misinformation out there and conclusions are being drawn based on a lack of knowledge instead of being based on a deep understanding.

This article will cover the interesting topic about how to classify whether the activity you are doing is considered trading or gambling and will uncover how to ascertain whether what you are trading is a financial instrument or not.

It appears, based on a recent article, that regulators in different countries do not know whether to classify binary options as a financial instrument or gambling. This statement shows a shallow understanding of binary options as well as financial instruments. There are a number of types of binary options and this article appears to imply that there is only one. For example, there are fully regulated binary options that trade on the NYSE and NADEX. There is also a Binary Options Exchange where you can be the writer and seller of binary options.

Gambling or financial instrument?

According to the Merriam-Webster dictionary, gambling is defined as “to bet on an uncertain outcome”. Isn’t trading any financial instrument according to this definition gambling? Well, it is if you are just looking at the outcome of one individual trade in isolation. If on the other hand, you are trading a system that has a positive expectancy then the outcome of a large enough number of trades is not uncertain anymore – you will make money!

I would like to offer a different and novel approach to understanding the nature of trading and gambling.

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The approach is based on a two prong analysis that looks at both the nature of the “instrument” that you are trading and how you are trading.

  1. What are you are trading? If there is no system that can be developed that has a positive expectancy, then you are gambling and what you are “trading” is not a viable financial instrument.
  2. How are you trading? If you trade any financial instrument without a strategy that has a positive expectancy, then you are gambling.

Let us take a look at a few examples to see whether you are gambling or trading.

  1. Playing the slot machines in a casino. This is clearly gambling as the odds are in the favor of the slot machines over time. If you play long enough you will always lose. The casino always wins.
  2. Trading options with a system that has a positive expectancy. This is clearly trading and not gambling as you will make money over time even though the outcome of any one trade is unknown.
  3. Trading stocks without a system that has a positive expectancy. This is clearly gambling according to our 2 prong test above, as it is uncertain whether you will make money over time. So in this example, you can see that even though you are “trading” a financial instrument, what you are doing is still considered gambling.

Expectancy type could settle the dilemma

To address the issue as to whether binary options are gambling or trading, you have systematically look at each category of binary options and decide whether you can develop a system that has a positive expectancy or not. If there does not exist a system of trading that has a positive expectancy, then you are gambling and what you are trading is not a financial instrument. If on the other hand, you can develop a system of trading that has a positive expectancy, then you are trading and what you are trading is a viable financial instrument.

If you take a look, on the surface, at trading binary options through an OTC (over-the-counter) binary options broker, it would appear that you may be gambling. This is because, on the other side of each of your trades, is the broker.

The odds are in the broker’s favor. This is because you can only be the buyer of the binary options. You can either buy a put or a call. If you win you will always profit less than what you risked. For example, in the language of most binary options brokers, you can make 80% return if you are right. This means that you will have to risk $100 to make $80 and if you are right 50% of the time, you will have a negative expectancy. The broker, on the other hand, will have a positive expectancy.

The only way that you can make money over time when your reward is less than your risk is ONLY if you are able to develop a system of trading that increases the percentage of winning trades to a point at which you will have a positive expectancy.

Is binary options trading gambling?

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It is more about whether you are gambling with binary options.

If your decisions are educated and your strategy has a positive expectancy then you are not gambling.

If you make bets for the thrive of the game or the hope of getting rich quick then you are gambling.

Seasoned poker players are not gambling. Card-counters are not gambling. On the other hand, many “investors” are gambling with “safe” stocks.

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  • Binomo
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