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It has been suggested that this article be merged into Binary option. (Discuss) Proposed since December 2012.

A binary options trading platform (also called binary options web site) is a web-based, over-the-counter, real-time trading system, which offers nonprofessional investors a way to wager on the short-term price movement of some underlying asset (e.g., stock, commodity, currency, index) 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 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.

Trading Platform

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 an investor from an option that expires in the money will usually be between 61% to 85% of 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. On most platforms there is a minimum amount for an investment, starting from as low as $10.

Examples of 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 characteristics), (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 than in the above formula. In order for a trader to make a long term profit he has to predict correctly roughly 54.5% of the time (depending on in-the-money and out-of-the money payouts).

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 a policy change regarding the classification of binary options as financial instruments. The effect is that binary options platforms operating in Cyprus (where many of the platforms are based) will have to be CySEC regulated within six months of the date of the announcement. CySEC is the first EU and MiFID-member regulator to treat binary options as financial instruments.

Criticism

These platforms may be considered by some as 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. According to Gordon Pape, writing in Forbes:

"If people want to gamble, that’s their choice. But let’s not confuse that with investing. Binary options are a crapshoot, pure and simple."

References

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• Articles to be merged from December 2012
• Options
• Investment
• Derivatives (finance)