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Binary options trading platform (also called binary options web-site) is a web-based, over-the-counter, real-time trading arena, which offers nonprofessional investors a way to profit from correct, short term predictions of some underlying asset (e.g., stock, commodity, currency, index) price movement by buying binary options on that asset. Binary options platforms have been growing rapidly since mid-2008. It is estimated that around 90 such platforms (including white label products) have been in operation as of January 2012.

The user-friendly-commission free platforms offer standardized short term binary options with a pre-determined profit/loss, that cannot be liquidated (buy or sell to close) before expiry. These binary option platforms offer options on some 70 underlying assets, and a profit scenario of 61% to 85% on options that expire in the money and also weekend trading that offers payouts as high as up to 400%.

Platform trading

Trading on binary option platforms can be done with little to no knowledge of the stock market. An investor will only need to choose whether the price of some asset (underlying asset) will be higher (in the case of a call option) or lower (in the case of a put option) at the option's expiration. Binary options are offered for a time period of 60 minutes or less and are traded until 10 minutes before expiry.

Once a trader places a trade he sets the spot price of the underlying asset as the strike price for the option. From that moment on, if the price of the underlying asset increases and closes above this strike price by even as much as one pip the option will expire in the money (for call option). If the price of the underlying asset hasn’t changed at expiry, the investor receives his money back.

As opposed to exchange-traded binary options providers such as American Stock Exchange (Amex) or Chicago Board Options Exchange (CBOE), the binary options platforms do not charge any direct fees from investors buying an option. The profit to investor from an option that expires in the money will usually be between 61% to 85% on the initial investment (depending on the underlying asset). In case of expiry out of the money the investor will get a rebate of between 0% and 15% on his investment. In most platforms there is a minimum amount for investment, starting from as low as $10.

Examples of a binary option trades

A trader believes that McDonald’s stock (NYSE:MCD) will close above the current (spot) price of $74.93 by the end of the hour. The trader can invest $100 in McDonald’s binary call option on that outcome. If his prediction is correct his payout is $170 (70% profit). If he is incorrect and the stock closes below the strike price he loses 85% of his investment (gets a rebate of $15).

Another common form of binary option that is traded is a touch/no-touch, also called one-touch binary option. In one-touch binary option, if the price of Google's stock (NASDAQ:GOOG) is at $495 and a trader predicts that the stock will "touch" the $500 mark during the trading period he can buy a one-touch option. Once the stock's value "touches" the $500 mark, the trader would immediately earn a 60%-70% gain. If the stock doesn't touch the predicted range by the end of the trading period, the trader looses 85% to 100% of the investment.

Business model

The platforms do not charge fees from their investors. Their profit comes from the difference between the options that expire in the money to options that expire out of the money. This difference can be found by the formula below. In this (for each base asset with same expiry caristeristics), (W) is the in the money option payout in percentage terms (e.g. 1.7), (L) is the out of the money option payout in percentage terms (e.g. 0.15), ${\displaystyle (V_{1}),(V_{2})}$ are the turnovers of transactions made for each outcome (e.g $1,000), (S) is the platform's gain.

${\displaystyle S=-}$

In this example the platform's turnover is $2,000 and its profit is $150 or 7.5% on turnover. As the platform’s gain comes from the above formula, most platforms will be indifferent as to the outcome of a single trade. Note that if ${\displaystyle V_{1}}$ is not equal to ${\displaystyle V_{2}}$ then the platform will have to act as a market maker. This can cause the platform gain (S) to be more volatile then in the above formula. In a fair platform in order for the investor to make a long term profit he has to predict correctly 54.5% of the time.

Platform fairness

When judging the fairness of a platform the following points should be taken into account:

• The platform has a high trading volume.
• The platform offers price quotes from a reliable third party data provider (e.g. Thomson Reuters).
• The platform offers the same price quotes for simultaneously buying a put or a call option on the same base asset, strike price and expiration time.
• The platform is managing its exposures correctly (i.e. covering a call option trade with a relevant put option trade) meaning that the investors are not trading against the platform but against each other.
• Clients withdrawals are finalized within 2-3 business days (the client will receive the funds into his bank account within 5 business days (assuming all Anti Money Laundering documents are sent on time).

Regulation and compliance

On non regulated platforms clients’ money is not necessarily kept in a trust account, as required by regulation, and transactions are not monitored by a third party to ensure fair play. On May 3, 2012 the Cyprus Securities and Exchange Commission (CySEC) announced on a change of policy regarding binary options classification as financial instrument. The meaning of the announcement is that binary options platforms operating in Cyprus (where many of the platforms currently operate from) will have to be CySEC regulated within six months from the date of the announcement.

Criticism

These platforms may be considered by some as a gaming platforms rather than investment platforms because of their negative cumulative payout (they have an edge over the investor) and because they require little or no knowledge of the stock market to trade in.

Most platforms have their investors sign a “Terms and Conditions” document before trading that warns the investors about the risk involved in dealing with binary options. However, in light of the high risk involved, it would be expected that the risk of trading in binary options will appear in this document in bold letters as well as on the platform itself. In addition, advertisements for binary option trading platforms tend to highlight only the high profit but not the high risk involved.

References

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