Trading Binary Options in 2020 after ESMA’s decision to ban them

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The ESMA introduces limitations for binary options and CFDs in order to protect the investors

The Supervisory Board of the European Securities and Markets Authority (ESMA) agreed on measures to limit the provision of contracts for difference (CFD) and binary options to retail investors in the European Union on March 23, 2020.

Agreed measures include the following:

  1. Binary options: a ban on marketing, distribution or sale of binary options to retail investors.
  2. Contracts for difference: restriction on marketing, distribution or sale of CFD to retail investors. Possibilities of any transactions with contracts for difference, allowing retail investors to play on spreads (difference between the best prices of orders for a sale and the purchase of an asset at the same time) are significantly restricted.

Significant problem of investor protection

The ESMA, along with the National Competent Authorities (NCA), concluded that there is a significant problem of protecting the interests of investors in relation to CFDs and binary options. The foregoing is due to the complexity of processes and lack of transparency. Binary options and CFD inhere a built-in conflict of interest between providers and their customers, as well as risks of discrepancies in expected profits and losses.

The analysis of NCA on CFD trade in various EU jurisdictions shows that 74-89% of retail accounts usually lose money on their investments, with an average loss per customer ranging fr om 1,600 to 29,000 euros. The NCA analysis for binary options also showed permanent losses on the accounts of natural clients.

“The opportunities for generating a large income, simplicity of digital platforms and record low interest rates attract retail investors. But they suffer significant losses due to the complexity of financial products and excessive use of financial leverage”, commented Stephen Mayor, Chairman of the Supervisory Board.

List of agreed measures

In accordance with article 40 MiFID, the following decision was made:

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  1. Set limits of leverage (indices or multipliers) for retail investors are limited: from 30:1 to 2:1. Indicators vary depending on the volatility of main leverage:
    • 30:1 – for main currency pairs;
    • 20:1 – for non-core currency pairs, gold and major indices;
    • 10:1 – for goods other than gold and foreign exchange indices;
    • 5:1 – for individual shares and other control values;
    • 2:1 – for crypto conversions.
  2. Introduction of margin closing rule for each account. The foregoing will allow to standardize the margin percentage (with 50% of minimum required margin) due to which providers must close one or more open CFDs of retail customers.
  3. Ensuring protection against negative balance for each account. This will provide a total guaranteed lim it on the losses of retail customers.
  4. Establishing a restriction on incentives in the sphere of CFD trade.
  5. Standardizing the risk warning, including percentage of losses in the accounts of retail investors of CFD provider.

Next steps

The ESMA intends to publish the indicated measures in the Official Journal of the EU in the near future, and they will start to operate for binary options in a month, and for CFDs – in two months. Upon expiry of three months after start of application of the restrictions, the ESMA will re-consider the situation and may extend the validity of the measures.

How to Trade Binary Options Around News Events

A short guide for trading binary options before, during and after economic announcements, IPO’s and company news as we understand

Economic and business events are where the action takes place, whether in forex or binary options. Volumes, emotions and tempers all rise together before rate decisions or a new company product is being unveiled. The main reason for this is that everyone gets a point of reference about the financial instrument involved. This causes a surge in confidence and in decision-making. The so-called “risk-on.”

With binary options there are several points to take into consideration before trading an event. First is the magnitude of the event – will it move the price enough to give a clear indication for the duration of your preferred option and will it give enough information about its direction? Second is the duration of the option that should be chosen – is this event going to have a long-lasting effect or will it cause short-term volatility before it simmers down?

Choosing between high/low and touch options is the next step. The former are the most popular in such cases, but this would definitely be the best time to use the touch (or one-touch depending on their availability with your preferred broker) options. Bare in mind that the levels for touch options usually vary for the times when there is an event.

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The difference a piece of important news makes to the price is that it gives it momentum. The ripples are stronger right after the splash. With the binary options for five, 15, 30 and 60 minutes (not to mention the ones that last less than a minute) you can capture these waves right after they happen. This is among the strong points for such options, as well as the fact that events can give a strong indication of future movement which can also be taken advantage of with longer binary options.

There are also cons for trading these options. Even after a clear direction is established, there might be occasional deviations from the straightforward movement and some trades might fall within them with a duration that is too short. So selecting the entry point and length of the options is crucial, as well as good risk-reward ratio calculations.

Of course you can choose to go with a more proactive approach – trying to guess in advance if the event or announcement go your way and choose long-term options – daily, weekly and monthly – to be in line with research that you have made. There might be indications that a rate hike is imminent, or some leaked data shows a big change in the demand for oil, so you can trade on them if you believe the data or analyses. Only here, unlike forex, your possible gains and losses are predetermined.

Events offer rich possibilities to trade in binaries and the more available instruments there are, the more opportunities there will be. It is the simplest way of trading and can be done by simply looking at the price changing after the news breaks, but with some technical analyses it can have a higher success rate.

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

What Do 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.” 

Key Takeaways

  • Binary options have a clear expiration date, time, and strike price.
  • Traders profit from price fluctuations in multiple global markets using binary options, though those traded outside the U.S. are structured differently than those available on U.S. exchanges.
  • Non-U.S. binary options typically have a fixed payout and risk, and are offered by individual brokers rather than directly on an exchange.
  • While typical high-low binary options are the most common type of binary option, international brokers typically offer several other types of binaries as well.

Binary options outside the U.S. are an alternative for speculating or hedging but come with advantages and disadvantages. The positives include a known risk and reward, no commissions, innumerable strike prices, and expiry dates. Negatives include non-ownership of the traded asset, little regulatory oversight, and a winning payout that is usually less than the loss on losing trades.

Understanding Binary Options Outside the U.S

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, they are 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 broker discloses the strike price, expiration date, payout, and risk 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 from 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.

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, the 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 their 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 fluctuate from broker to broker and instrument to instrument, one thing remains constant: losing trades cost the trader more than they 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.

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