Investors who buy binary options probably know very little about calls or puts, or Black-Scholes valuations, but still, they swarm to brokers offering these questionable assets. Now, following the example of countries like Israel, the European Securities and Markets Authority, ESMA, have decided to apply the brakes.
Binary options have received a bad press for the past several years. Once a legitimate tool used by traders the world over as part of their overall investment strategy, these financial products have fallen from grace. The central cause of this change of fortune for the humble binary option is the green-eyed goddess—greed. Unscrupulous scammers identified a hole in the market and succeeded in packaging the binary option as a straightforward “safe” bet for naïve customers.
Put simply, the punter gambled whether an asset would rise or fall in a short period of time. As any professional trader knows, determining market direction from minute to minute is virtually impossible. Even if a trader gets the overall market direction correct, random, short-term fluctuations in that market can go against the trader at any time. A buyer of a binary option may gamble that the market goes up within a one-hour window, only to see it fall, then go up again two hours later. The punter “got it right”, but his timing was off and he lost money.
Trading is not a science, but short-term binary options trading is more of a game, and the odds favor the option seller. Due to this skewed risk, ESMA declared a three-to-six-month ban on the product across the EU until it was able to establish a set of rules for trading the financial instrument. This move was part of the Markets in Financial Instruments Directive (MiFID) of 2004 aimed at investor protection.
Some have called the ESMA ruling timely, while others, perhaps less charitably, have called the move too little, too late. Binary options scams have become widespread, and ESMA should probably have acted years ago. Additionally, some have called the ESMA recommendations lightweight. Current restrictions involve ensuring that the binary option maturity is at least 90 days. Another recommendation is that a formal prospectus is produced by the options writer. A third sanction, perhaps the most controversial of all, is that options buyers are unable to lose more money than was initially indicated upon purchase of the option. Essentially, this takes out any market risk from the option, which reduces the profit margin of the option seller.
Critics of the ESMA move have questioned why the European organization did not simply apply a blanket ban on trading of binary options, as was done by a number of countries such as Israel, where binary options scamming had become widespread. It could be assumed that ESMA’s actions were possibly designed to protect member organizations over any significant concern for individual investor risk.
ESMA initially banned trading in binary options from the beginning of July 2018 but has renewed that ban for a further three months from October 2018. Details of ESMA’s final decision on this topic will appear in the organization’s website and in the Official Journal of the EU. Following what is likely to be significant restrictions on binary options trading by the EU, other countries are likely to follow suit and restrict or ban trading in this financial instrument.
First published in FXStreet