Are Binary Options Gambling?

I believe that the 5-minute type binary options are gambling full-stop.  You can’t really analyse and predict a market direction whatsoever on so short a time-span.

Perspectives from a Quant

I think that as a quant I should make some points clear:

From a quant’s viewpoint it is clear to me that binary options have what I call implicit leverage while traditional forex trading can have explicit leverage. This makes it nearly as dangerous as forex trading.

For example let us enter a long position on the EUR/USD currently at 1.13900 with a the broker offering leverage of 200. Suppose the margin requirement is $500, then we are effectively making a bet on $100000 dollars (let us ignore commission and fees). Consider two scenarios: EUR/USD goes up to 1.14210 or down to 1.13590. Clearly a move of 0.0031 in currency.

In the first case your profit is 100000*(0.0031) = $310 and in the second case a loss of $310 (which is 310/500 = 62% of your ‘investment’ amount, the $500).

Now, let us replicate this using binary options. Suppose our broker is generous enough to give 90% payouts (yeah I know, unrealistically high). Let us put down an amount of $500. If we win, i.e. currency goes up then we get $450. If we lose we lose $500.

Essentially gambling (see end of this comment) on the forex pair using binary options in the above example is equivalent to putting a margin of $500 with a forex broker offering you around 290 in leverage (plus a massive spread!). In other words under this leverage we are effectively buying the currency with $145161.29 and if the price moves up by 0.00031 then we profit 0.0031*$145161.29 = $450. However, we lose an additional $50 in case of scenario 2. This can be seen as a spread of some sort, or commission.

If you followed the argument then this means for the same amount ‘invested’/gambled the binary option has an implicit leverage that can be higher than the explicit leverage on the forex product. Of course the most brokers give 70-80% payouts which reduces the leverage but increases the spread; You lose either way.

Secondly, even with fees and commissions, your loss on a losing trade, i.e. the $500 on the forex (assuming stop loss on forex is set to equal margin put up) can only happen if the price really moves against you. On the binary options if the price moved down just 0.00001 then you lose everything, i.e. no risk management. (Don’t tell me brokers “sell-back” options, in fact our formulas show that these sell-back prices are far below the theoretically and market (Binary.com for comparison) correct prices. Clearly they don’t want you to sell.).

Trading on prices in a very short time frame, i.e. 60 seconds is gambling. Indeed we compared the Hurst parameter, fractional dimension, tests for white noise, and other quantities that show us effectively for most of a normal trading day you can not mathematically predict currency movements, or other assets. And if the so-called technical analysis tells you there is a trend then be prepared for surprises. Our most sophisticated models can’t predict movements in 60 seconds (consistently, didn’t stop us from trying as a joke activity) and it is sad that retail traders who don’t even have a fraction of the tools or computing power think they can outperform, except of course the lucky ones (elementary 1st year university statistics predicts that, so they are lucky not talented).

My point is that many uneducated people are unknowingly taken up by such scams. Even if very short-term binary options trading seems easier, it is not. It is not an up/down prediction. There is also a time horizon to consider that often results in the frustration, “If I had only clicked the call button a second sooner then it would have been a win!”. That gives the trading 2 dimensions to consider. Unfortunately technical analysis cannot give you the latter (of course quantitative analysis can!)

Lastly, the majority of these brokers are scammers and unregulated, despite terrible payout odds like 80% (compared to 97% at almost all Casinos; isn’t roulette like binary options??) there has been so many people that are not given back their money. I personally have beaten 3 brokers by trading out bonuses and accruing account balances over $30000. To date these binary brokers have given me $0 and suspended my account on many grounds, including “cheating” (well using 200 computers to compute trading calculations in seconds could be seen as unfair, although these guys don’t know that! And of course our team took this trading as a kind of joke, some afternoon lunch entertainment!).

So if you’re an individual with no experience trading then keep your money safe in a bank deposit or retail bond. If you are an experienced trader then trade somewhere else, either traditional futures and options or if you’re the adventurous kind you can try the longer binary time-plays offered by some legitimate (read: regulated) binary providers. For myself I only trust Binary.com and IQOption these days.

Feel free if to comment if you disagree with my “implicit leverage” argument.