By Kevin Fish
Binary options are a simple yes or no proposition, hence the name “binary” option; and the proposition is: Will the underlying asset be at a certain price at a certain time? A binary call option is a prediction that the underlying asset will increase and a binary put is a prediction that the underlying asset will decrease.
For example, if underlying stock XYZ was trading at 2,300 and I believed that by the close of the trading day, XYZ would be above 2,310, I might take out a binary call option. If the underlying stock is at or above that price at the end of the trading day (expiration period), I would make a 100% return. However, if the price is below at the expiration period, then I lose 100% of my investment. Therefore, the average return on investment for this binary option is zero.
Although the average return on investment should be zero, many binary option offerings are a net loss for investors. The payout is much smaller than the loss on most binary options. For example, you purchase a binary option for $60, you may stand to win $30 but lose all $60. Online binary option trading platforms will often advertise a higher average return on investment than a customer would expect to hide the fact that the average customer can expect a net loss.
Retail investors are mostly purchasing binary options through these online trading platforms, like Binary Cent, Binary Mate, 24 Option, etc. These platforms require the investor to deposit a sum of money to purchase the option. If the investor chooses the wrong proposition, then the option expires out of the money and the platform takes all the investor’s deposit with no refund.
Binary options existed for many years, however before 2008 they were only available to large institutional traders and high net-worth individuals through the over-the-counter market. In 2007, the Options Clearing Commission recommended changes in binary options to make them more available to retail traders. In 2008, the SEC approved the offering of binary options as tradeable investment instruments. Not long after, the Chicago Board Options Exchange and the American Stock Exchange began offering binary options for public trading.
Since binary options were made available to retail investors in 2008, they have proven to be problematic. Retail investors have lodged many complaints for fraudulent activity against the internet platforms that trade binary options and the SEC issued an investor alert on binary options in November of 2016.
The SEC has quickly pumped the brakes on this new investment instrument to retail traders with the advent of numerous instances of fraudulent activity by online trading platforms in connection with trading binary options. While some binary options are listed on registered exchanges, most binary options are listed through online trading platforms. These trading platforms do not necessarily comply with US regulations. The fraud associated with these trading platforms fall into three categories: (1) refusal to credit customer accounts or reimburse funds to customers when the customer tries to withdraw money; (2) identify theft; and (3) manipulation of software to affect whether trades win or lose.
Investors must be cautious of the online trading platforms that offer binary options. The online platforms are unregistered and are not licensed to provide investment advice, and therefore investors who use the platforms may not receive the protections of the federal securities and commodities laws.