At the same time they charged Banc De Binary Ltd., a Cyprus-based company, with illegally selling binary options to U.S. investors. 10 11In the UK, the Department for Culture, Media and Sport have written to the Gambling Commission suggesting binary options are to be reclassified from fixed odds bets to financial instruments. 12 This would mean regulation falls under the remit of the Financial Conduct Authority. This would be a significant step in the regulation of binary options as FCA regulation would carry much more weight both with European members and UK consumers.These platforms may be considered by some as gaming platforms rather than investment platforms because of their negative cumulative payout (they have an edge over the investor) and because they require little or no knowledge of the stock market to trade. According to Gordon Pape, writing in Forbes, this sort of thing can quickly become addictive...no one, no matter how knowledgeable, can consistently predict what a stock or commodity will do within a short time frame. 13In 2007, the Options Clearing Corporation proposed a rule change to allow binary options, 14 and the Securities and Exchange Commission approved listing cash-or-nothing binary options in 2008. 15 In May 2008, the American Stock Exchange (Amex) launched exchange-traded European cash-or-nothing binary options, and the Chicago Board Options Exchange (CBOE) followed in June 2008. The standardization of binary options allows them to be exchange-traded with continuous quotations.Amex offers binary options on some ETFs and a few highly liquid equities such as Citigroup and Google. Amex calls binary options Fixed Return Options (FROs) calls are named Finish High and puts are named Finish Low. To reduce the threat of market manipulation of single stocks, Amex FROs use a settlement index defined as a volume-weighted average of trades on the expiration day. Amex and Donato A. Montanaro submitted a patent application for exchange-listed binary options using a volume-weighted settlement index in 2005. 16CBOE offers binary options on the SampP 500 (SPX) and the CBOE Volatility Index (VIX). 17 The tickers for these are BSZ 18 and BVZ, respectively. 19 CBOE only offers calls, as binary put options are trivial to create synthetically from binary call options. BSZ strikes are at 5-point intervals and BVZ strikes are at 1-point intervals. The actual underlying to BSZ and BVZ are based on the opening prices of index basket members.A trader who thinks that the EUR/USD price will close at or above 1.2500 at 3:00160p.m. can buy a call option on that outcome. A trader who thinks that the EUR/USD price will close at or below 1.2500 at 3:00160p.m. can buy a put option or sell a call option contract.The risk involved in this trade is known. The traders gross profit/loss follows the all or nothing principle. He can lose all the money he invested, which in this case is 40 x 10 400, or make a gross profit of 100 x 10 1,000. If the EUR/USD price will close at or above 1.2500 at 3:00160p.m. the traders net profit will be the payoff at expiry minus the cost of the option: 1,000 400 600.The trader can also choose to liquidate (buy or sell in order to close) his position prior to expiration, at which point the option value is not guaranteed to be 100. The larger the gap between the spot price and the strike price, the value of the option decreases, as the option is less likely to expire in the money.In the BlackScholes model, the price of the option can be found by the formulas below. 21 In fact, the BlackScholes formula for the price of a vanilla call option (or put option) can be interpreted by decomposing a call option into an asset-or-nothing call option minus a cash-or-nothing call option, and similarly for a put the binary options are easier to analyze, and correspond to the two terms in the BlackScholes formula.If we denote by S the FOR/DOM exchange rate (i.e., 1 unit of foreign currency is worth S units of domestic currency) we can observe that paying out 1 unit of the domestic currency if the spot at maturity is above or below the strike is exactly like a cash-or nothing call and put respectively. Similarly, paying out 1 unit of the foreign currency if the spot at maturity is above or below the strike is exactly like an asset-or nothing call and put respectively. Hence if we now take , the foreign interest rate, , the domestic interest rate, and the rest as above, we get the following results.In the standard BlackScholes model, one can interpret the premium of the binary option in the risk-neutral world as the expected value probability of being in-the-money unit, discounted to the present value. The BlackScholes model relies on symmetry of distribution and ignores the skewness of the distribution of the asset. Market makers adjust for such skewness by, instead of using a single standard deviation for the underlying asset across all strikes, incorporating a variable one where volatility depends on strike price, thus incorporating the volatility skew into account. The skew matters because it affects the binary considerably more than the regular options.A binary call option is, at long expirations, similar to a tight call spread using two vanilla options.
