When the Swiss National Bank (SNB) eliminated the 1.20-peg to the Euro, it sent shockwaves throughout the entire foreign exchange industry, let alone all financial markets to some degree. Why Swiss officials chose to surprise the world with its rash and devastating policy reversal will remain an open question, but, behind the scenes, analysts across the globe are still assessing the damage. Amidst the carnage, there are still many details that will reveal themselves over the next few months. Back office reconciliations will take many man-hours to sort out. New capital will need to be raised, and confidence restored.
Very little has been heard, however, from binary option brokers, the fastest growing segment of the foreign exchange trading arena. Did they have any horror stories to tell? Were there any stories of halts to trading sessions or regarding urgent pleas for more capital? Should the risk profile of this segment suddenly come under more scrutiny? Surprisingly enough, there was very little, if any, commotion in this sector. While others dealt with the rubble in their shops, binary option brokers were pretty much “business as usual”, or, as some observers have surmised, they were “relatively immune to the effects of last week’s drastic moves”.
In an exclusive interview with LeapRate, Pini Peter, Chairman of leading binary options platform provider SpotOption, shared his insider knowledge on how the SNB decision to remove the 1.20 floor on the “EUR/CHF” currency pair, now being termed a “Black Swan Event”, rippled through the binary option industry. His remarks highlighted the apparent risk differences between traditional versus binary trading modalities.
What are the major differences between traditional and binary option trading?
The primary difference is how the spread determines the final outcome of the trade. In the traditional mode, the spread is variable, as offered by liquidity providers. Stop losses are used to protect against large movements to the downside, but this device does not always work when turbulent change hits the market, as when the SNB made its surprise announcement. Then, all bests are off, and losses are in free fall. If leveraged, then the losses can be astronomical. With a binary option, the size of the spread is not important, but the direction of the movement is.
As Peter points out, “In a binary option, the spread does not play a role in the outcome. The outcome (profit or loss) is the same whether the asset price moved by a single pip or by 25%. The profit and loss is known from the onset of the trade, exactly how much they stand to earn, and how much they stand to lose upon the expiry of the option. Traders know this, and brokers know exactly their exposure upon trades taken on their system making ‘worst case scenarios’ a known amount at any point in time, and therefore much easier to deal with and to plan for.”
In other words, momentary spikes in price valuations are irrelevant to both binary option brokers and their trading customers. There is, however, one rare exception. There are several binary option brokers that offer what is called a “Ladder Option”. Payoffs can extend up to as high as 1000%, if you guess correctly the direction and the ladder “rung” where the spread reaches a higher value. Brokers could have sustained a higher loss in this case, but these items would have been few in number and isolated.
There is also the problem of being “stopped out” in the traditional world. Fixing the price for a stop-loss order when the Bid/Ask spread is expanding drastically can only result in larger losses, once again. Per Peter, once more, “We didn’t have the problem of many traders being ‘stopped out’ all at once, as the Forex world did seeing a liquidity panic even once the EURCHF found sounder footing. Part of the problem the Forex world had and had to sort out was what price traders were stopped out at. In Binary trading, the outcome in any trade is fixed from the outset. It makes no difference if the EUR is slightly down on the CHF or vastly down, the outcome is the same.”
Are binary option brokers less risky than traditional forex brokers?
As a twist on an old saying, Risk is in the eye of the beholder. Risk comes in many forms, and many of these apply to all operations, no matter what forex sector. The binary option space has been growing rapidly. New brokers have been joining the fray monthly, although new entrants seem to be tailing off of late. The current concern is what might happen when the tide of new customers subsides. All new and old ventures have one similar type of “Operational Risk” – they must generate enough revenue to recover costs and operate at a profit before their capital runs out. There may also be legal and regulatory risk issues, as well, but only time will tell.
The industry lacks an RSI-like indicator to show when it is over saturated with brokers. When that point is reached, broker sales, consolidations, and failures will proliferate. Client deposits may be at risk, unless they were segregated in Tier-1 bank accounts, per strict regulatory standards. Nearly all binary option brokers are also located in far off locales, as well. Trying to press your legal rights in a foreign jurisdiction can be a nightmare and is often described an exercise in futility.
One good piece of news, at least for clients of highly impacted forex brokers, is that most brokers are conceding that they will not go after their customers to collect negative balances. The industry is said to have reached this conclusion because it did not wish to drive customers away from forex forever. Press releases stating such a position are appearing across the wires from firms like FXCM and Gain, just to mention two major and well-established forex brokerage houses.
For all intents and purposes, it appears like the binary option broker community dodged the SNB silver bullet, at least this time around. The industry may still have growing pains to endure, but the SNB snafu may yet have a silver lining for binary option brokers. Many industry pundits are already predicting that a new wave of customers, severely disenchanted by the Swiss Franc mess, will hit the binary option “shore” in the near term. The boost could be two-fold and enliven an already burgeoning industry.
According to Pini Peter’s appraisal, “I think that those looking to trade, as well as those looking to start a new brokerage, will look at Binary Options in a very different light now. Moreover, we expect to work with even more Forex brokerages looking to add regulated Binary Options trading for their existing clients. We believe that Forex brokerages will now view offering Binary Trading as a much lower-risk way of engaging with clients.”
Hope springs eternal, but always be wary of risk issues. Due diligence does not stop after choosing your broker. The process is meant to be an ongoing one. Good Luck!