By Darrell Martin
Binary options are a growing trading instrument expanding rapidly around the globe.
As they continue to grow in popularity, many people weigh in with their opinion.
Like most things in the financial world, people are quick to give opinions without knowing the facts. They may have read an article or a forum thread, saw a video on YouTube, had a bad experience, made mistakes and did not know it – or flat out are just making stuff up.
As absurd as it sounds, there are many sites out there trying to market their product or direct the consumer towards their binary broker or service. and they will post inaccurate content. This leads to a lot of confusion.
Related: What Is A Nadex Binary Option?
To help eliminate this confusion, listed below are five common misconceptions, followed by the facts to help you become more informed about the world of binary options.
- Binary Options Are Not ‘Really’ Regulated
Fact: Although many binary “bucket shops” do not have regulation, there are several types of regulation. The question is what does “real” regulation, versus just being registered, mean.
Registration is being signed up with an organization such as the Better Business Bureau that has no power to enforce penalties, seize assets or prosecute for violation of its own Rules and Regulations. It can post nasty messages or send you a fine letter, but in the end, it doesn’t have any real power to protect you, the consumer, beyond a bulletin board of warnings.
Real regulation means there is a regulator with the power to impose and enforce fines and punishments for violations of regulations, in order to protect the trading members. The CFTC is the Commodity Future Trading Commission. It oversees the CME/Nymex/Comex and also NADEX. Nadex is the North American Derivatives Exchange. It offers binary options and is regulated by a real regulator. It is the only retail-focused CFTC Regulated binary exchange in the United States offering binaries on US and International Indices, Forex, and Commodities.
The CFTC clearly states that the North American Derivatives Exchange is a regulated, designated contract market for offering binary options.
- Binaries Are Always a Yes/No, Up/Down Trade
Fact: As of expiration, binaries are a yes/no or true/false proposition – stating that an underlying market must be above or below a strike by expiration. But this is not the case with all binaries. On Nadex, on every single binary contract, you can enter and exit before expiration. Therefore as the price rises or falls, you can enter and exit the trade. One of the biggest facts that separates trading from gambling in the binary world is the ability to exit a position before expiration.
In addition, on Nadex you can buy and sell binaries at different strikes – creating premium collection, range bound, and random walk (strangle) strategies.
- You Have To Hold Until Expiration
Fact: As stated in the previous entry, binaries do not have to be held until expiration on Nadex. Though all contracts on Nadex have capped risk, you do not have to take the maximum risk. You can exit early to limit losses, and you can exit early to lock in profits.
- Binary Pricing Is Randomly Made Up
Fact: Binary pricing can be manipulated over-the-counter, where the payouts are skewed. However binary options on an exchange such as Nadex are based upon a Black Scholes model. A vertical Black Scholes model will show a similar binary pricing while held until expiration.
A simpler explanation is that it is a reflection of delta of a call option, with the same strike and same expiration date and time. Therefore, the other option Greeks – such as gamma, theta, vega and rho – can equally be applied and extracted from the binary’s price. If the price is manipulated and off by too much, then arbitrage will be available and quickly bring it back into line like on any other market.
- Liquidity Is Low
Fact: Some binary exchanges and many “bucket shops” will do a request for a quote, do not have enough liquidity and may do a requote. Many of these binary brokers will say they have no bid/ask spread, but they only pay out $70 on a $100 risk. So, right out of the gate, you are out $30 “bid/ask spread” or whatever they want to call it.
Nadex is a true exchange with no request for a quote. They do not take the other side of your trade. They do not profit from the bid/ask spread. The pricing is transparent and the liquidity is immediately visible for the best price three levels deep. Contracts may have 10 or even 900 available. The number will be consistent for the specific market and time of day.
Liquidity impacts any market. For example, on the futures market, Corn Futures have less liquidity than the S&P 500 Emini Futures. You should expect the same on corn binaries versus S&P 500 future binaries on Nadex (a.k.a. US 500). Certain times of day or night will also have more trader demand.
As on any market – futures, options, forex, etc. – this will determine the liquidity and bid/ask spreads. A two-hour contract will have less liquidity than a one-day contract – which, in turn, will have less than a one-week contract. However, the liquidity is known up front when you enter and it remains consistent.
A simple look at comparing Nadex binaries to many verticals, even on the most popular of Indices ETF’, will show you the liquidity is quite sufficient to meet even the large trader’s needs. If you are a large trader in need of high liquidity, always make sure to choose the correct expiration and the correct markets that are more liquid.
As shown in the example below, you can see there are 500 contracts available this second at the quotes displayed. Clicking on a ticket shows you more depth of other traders providing more liquidity. If all the traders are taken out, then more liquidity will be added back in, due to market makers contractual obligations to make markets.