The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. They are also called all-or-nothing options, digital options (more common in forex/interest rate markets), and fixed return options (FROs) (on the American Stock Exchange). 1For example, a purchase is made of a binary cash-or-nothing call option on XYZ Corps stock struck at 100 with a binary payoff of 1,000. Then, if at the future maturity date, often referred to as an expiry date, the stock is trading at above 100, 1,000 is received. If the stock is trading below 100, no money is received. And if the stock is trading at 100, the money is returned to the purchaser.The value of a digital option can be expressed in terms of the probability of exceeding a certain value, that is, the cumulative distribution function, which in the Black-Scholes equation is the Gaussian. Due to the difficulty for market-makers to hedge binary options that are near the strike price around expiry, these are much less liquid than vanilla options (that is, standard and ordinary call and put options). Dealers often replicate them using vertical spreads, which provides a rough, inexact hedge.Though binary options sometimes trade on regulated exchanges, they are generally unregulated, trading on the internet, and prone to fraud. 1 The U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have issued a joint warning to American investors regarding unregulated binary options. 2On May 3, 2012, the Cyprus Securities and Exchange Commission (CySEC) announced a policy change regarding the classification of binary options as financial instruments. The effect is that binary options platforms operating in Cyprus, where many of the platforms are based, will have to be CySEC regulated within six months of the date of the announcement. CySEC was the first EU MiFID-member regulator to treat binary options as financial instruments. 4In March 2013, Maltas Financial Services Authority announced that binary options regulation would be transferred away from Maltas Lottery and Gaming Authority. 5 On 18 June 2013, Maltas Financial Services Authority confirmed that in their view binary options fell under the scope of the Markets in Financial Instruments Directive (MiFID) 2004/39/EC. With this announcement Malta became the second EU jurisdiction to regulate binary options as a financial instrument, providers will now have to gain a category 3 Investment Services licence and conform to MiFIDs minimum capital requirements. 6 Prior to this announcement it had been possible for firms to operate from the jurisdiction provided the firm had a valid Lottery and Gaming Authority licence.In 2013, CySEC prevailed over the disreputable binary options brokers and communicated intensively with traders in order to prevent the risks of using unregulated financial services. On September 19, 2013, Cyprus Securities and Exchange Commission (CySEC) sent out a press release warning investors against binary options broker TraderXP, CySEC stated that TraderXP is not and has never been licensed by CySEC. 7 On October 18, 2013, CySEC released an investor warning about binary options broker NRGbinary and its parent company NRG Capital (CY) Ltd., stating that NRGbinary is not and has never been licensed by CySEC. 8The Cypriot regulator also temporarily suspended the license of the Cedar Finance on December 19, 2013. The decision was taken by Cyprus Securities and Exchange Commission(CySEC) because the potential violations referenced appear to seriously endanger the interests of the companys customers and the proper functioning of capital markets, as described in the official issued press release.CySEC also issued a warning against binary option broker PlanetOption at the end of the year and another warning against binary option broker LBinary on January 10, 2014, pointing out that it is not regulated by the Commission and the Commission has not received any notification by any of its counterparts in other European countries to the effect of this firm being a regulated provider.As far as penalties are concerned, the Cyprus regulator imposed a penalty of 15,000 against ZoomTrader. OptionBravo and ChargeXP were also financially penalized. CySEC also indicated that it has voted to reject the ShortOption license application. 9The U.S. Commodity Futures Trading Commission (CFTC) oversees the regulation of futures, options, and swaps trading in the United States. On June 6, 2013, the CFTC and the U.S. Securities and Exchange Commission jointly issued an Investor Alert to warn about fraudulent promotional schemes involving binary options and binary options trading platforms. 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.
