Binary options industry enduring a period of increased regulatory scrutiny

Chris Lee

Popularity has a price, especially if shady business operators are attracted to it, as well. The binary options industry has been in the headlines of late and not from a good perspective. After several years of incredible popularity and astronomical growth, this simplified form of trading is finally evolving from its own “Wild, Wild West” early development phase to something more attune to early adulthood. Yes, the past few years have been fun and exciting, but the lack of stiff regulatory oversight has resulted in a business model that is vaguely similar to the early days of retail forex trading.

As in the first decade after the nineties, regulators are now determined to drive out the bad aspects of binary options and to welcome a host of new and improved business practices, each designed to provide a fairer and more transparent service to consumers. The days of leniency have led to abuse in some quarters in such areas as expiration price determinations, bid/ask price manipulations, aggressive cold calling campaigns for new and increased deposits, dealing desk conflicts of interest, confusing bonus promotion trading requirements that block withdrawals, and the list goes on and on.

Major brokers are now jumping into the fray, after years of believing that these “all-or-nothing” instruments were nothing more than just a passing gambling fad. Binary options have definitely simplified many aspects of traditional trading, but these simplifications have come at a cost that is not often understood by newcomers to the field. Consumers can easily be swayed to behaving as if they are in a casino, ignoring prudent techniques that ensure a chance at good performance and opting instead for what delivers the highest adrenalin rush at the moment. Under these conditions, the House always wins. If fairness is a worthy goal, then standards must be raised before things get out of hand.

Binary options are following a natural evolutionary path

To begin with, the binary options industry is not in disarray, far from it. As with traditional retail forex trading, the maturation process of this very new and popular venue has proceeded down a fairly predictable set of stages to where it is today. Some eight years back, online trading was the rage, both in currencies and other financial instruments. Casualty rates, however, were extremely high, over 65% by most accounts. Not everyone was cut out to be a trader. The learning curve was lengthy. The required practice regimen was arduous, and, as a result, most newcomers grew impatient and undisciplined, the quintessential formula for failure.

Such conditions were ripe for an innovative market response, one that would remove the complexities of trading and make it fun again. Binary options came into being, and hoards of consumers suddenly switched allegiances from their trusted brokers and plunged head first into this new and exciting offering. Simplicity and the potential for large and immediate returns were too enticing to ignore. All one had to do was pick an asset, select an expiration period, guess up or down, wager a fixed amount, and execute the order. If you guessed correctly, then a 75% return was common, and if you lost, you might even get 10% back. What was not to like?

The apparent advantages of these new fangled options did not come without a cost. Returns of 75% were the exception, as were 10% rebates. Yes, there was an occasional option where the odds were reasonable, but the deck was stacked in favor of the House. Competition had yet to arrive to force an improvement in payoff ratios. Basic risk management techniques, often the most confusing part of traditional trading, were all but eliminated by this medium, except for one thing. Yes, the risk aspects of your order were fixed and disclosed when you hit the “Execute” button, but there was another form of risk that traders quite frankly ignored at the outset.

Brokers for these “all-or-noting” options, by necessity, were located in far off tax havens, where casino betting was legal and offered a supply of back-office employees trained in the proper disciplines to run these innovative operations. Traditional brokers did not have these resources and chose to watch from the sidelines, expecting the fad to fade away. Consequently, a trader had to choose a foreign-based broker, typically in an unregulated locale, where anything went and did. The operation was related to pari-mutuel betting, where the House creates the odds, takes a cut of the overall bets, and consumers are left to be “net” losers in the deal. There were no market-based securities, unless the broker chose to hedge an exposure to protect its downside risk.

Binary options were ahead of the game from a regulatory perspective, as well. Most regulators had no idea how to deal with them. Canada and the United States labeled them as outright gambling, forbidding their existence unless traded on a regulated exchange. The UK and the rest of Europe bought into the fad immediately. The demand was so great that new brokers were popping up every week. Many went to Cyprus, where regulation was present, but viewed as lax. Innovation thrives when regulators are more accommodating. Cyprus was also thriving as a new financial center, where CySEC license authorizations enabled blanket coverage over the entire European Union.

What events created competitive pressures in the industry?

As stated, popularity has a price. When a financial service is popular and a hot item, word spreads quickly, and a fair share of the criminal element of our society began to salivate in anticipation of new fortunes to be made. The early cross-border nature of the brokerage community for these options also encouraged a few business operators to rig the system in their favor. High turnover also forced marketing operations to be always in high gear, a process many brokers outsourced to burgeoning cold-calling companies that set up shop in Israel, where regulators looked the other way.

Many termed these conditions as mere growing pains that every industry must endure, but then a major financial crisis hit the island of Cyprus in 2013, sending many brokers into foreclosure or making many chase after new capital or an acquirer to stay in business. The two largest banks on the island were closed due to devalued Greek bonds. The smaller of the two was shut down, while the Bank of Cyprus still stumbles along today, after survival was assured via a deposit “haircut” and a bailout package. The island’s economy has recovered, and CySEC has stiffened regulations in response.

Fast forward to today, and you also have increased pressure from traditional brokers that now have subsidiaries devoted entirely to binary options. These brokers offer “one-stop shopping under one roof” and the peace of mind of top of the line regulatory oversight. The squeeze is on, so to speak, and many binary option brokers that were operating on the edge financially are now in desperate straights. This phase of growth is typically called a consolidation period, where winners move ahead, and losers leave the playing field, a process aided by the institution of stiffer standards by regulators.

What form have these stiffer standards taken in the marketplace?

Binary options are here to stay. They are not a passing fad. Unfortunately, the shadier practitioners of this new art form have brought about an avalanche of complaints from consumers on such a scale that regulators the world over have had to step up their consumer protection campaigns. The vast majority of the complaints originate due to aggressive solicitation efforts, emanating from offshore locations.

In these cases, regulators can only publish alerts and warnings or seek the cooperative support from the appropriate foreign regulatory agency, if there is one. Law firms in both the UK and France are moving forward with plans to sue “boiler-room” type firms in Israel for fraud and questionable business practices because local law enforcement refuses to act. The targeted firms are smart enough to avoid calling Israeli citizens. Without complaints from local citizens, regulators and law enforcement officials have their hands tied, so to speak.

Much of the cited abuse stems from a number of companies operating out of Cyprus. After 2013, registration and licensing regulations were strengthened, but recently CySEC published a circular, as we reported in April, that established “a new set of tougher standards for the forex and binary options brokers under its domain. Within the next 90-day period, these brokers must:

1)    Provide more transparency related to the underlying asset that is being traded related to the trading venue and the specific identity of the asset;

2)    Present a continuous flow of Bid/Ask spread information on the asset during the complete holding period up until the expiration point, such information to be easily visible on the trading platform;

3)    Disclose how the final strike price is calculated and from what source it has been obtained;

4)    Provide price history charts or graphs that are “accurate, clear and understandable to the average investor as to the describing illustrations”;

5)    With the exception of 30-second options, provide a capability of canceling the option within a reasonable amount of time, such time to be greater than three seconds after the binary option is executed.”

Trading platform designers are quickly developing new code to incorporate these changes, and time will tell if these new rules create a “fairer and more transparent service” for the public at large.

Concluding Remarks

Binary options have been the new “toy” in the trading community for nearly a decade, and it has been the fastest growing segment in the industry, drawing newcomers across the globe from every venue of trading. They are popular, and they are here to stay. With increased regulatory scrutiny, the consumer experience will hopefully be a better one, with fewer complaints, more transparent business practices, and less fraud.

Consumers, however, have a role to play, as well, one that requires effort on their part to be successful. Take your time choosing a broker that offers binary options. Read reviews. Check with other traders. Remember the risk aspects of dealing with a broker in a foreign jurisdiction, where your legal rights may not be protected. Heed the warnings of your local regulator, too. Do your homework, and do not fall for the first great bonus deal that comes your way. You may regret it later.

Last of all, do not fall victim to the siren call of the gambling mind. You can win consistently with binary options if you follow a step-by-step plan that tilts the odds in your favor. Technical analysis is the best tool for these strategies. Practice, be patient, and then perform.

Chris Lee

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