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Are binary options too good to be true?

in Financial Negligence by James Naughton on

“Binary options” are the new buzzwords in trading. Slick new apps are being developed and marketed to Australians to trade in these exotic, complex sounding options. But is it all too good to be true?

We're currently seeing a host of binary options apps being marketed through social media. They appear to promise easy access to the world of options trading, promoting the prospect of success. They call on investors who are ‘ready’ to earn large profits.

The reality is that there is a dark side to binary options trading. We have been contacted by everyday consumers that have lost thousands to overseas companies through trading in binary options. We are concerned that in some cases, these losses may have been incurred without investors fully appreciating the risks.

In other cases, we've been contacted by people who have sent money to questionable online brokers; who initially promise success but then appear to lead their clients to significant losses.

Some of these ‘brokers’ appear to be little more than sophisticated scammers.

The binary options trades sold by online brokers often encourage investors to predict the movement of a commodity, index or exchange rate, for example, the price of gold or the $US to $AUD exchange rate. Investors try to predict how the market will move. If the investor guesses correctly, the investor usually takes a fixed monetary amount, usually expressed as a percentage gain on their original investment. If the investor guesses incorrectly, the investor usually loses all of their invested money.

To provide an example, an investor purchases an option which will pay out if the Australian dollar will exceed 75 US cents by 11 am the following day. The investor purchases the option for $100. If the investor guesses correctly, he or she will receive a percentage (say 25%) of the invested amount, and will have their capital returned ($100 + $25 = $125). If the investor guesses incorrectly, the option will expire, and the investor will lose their $100.

From the example above, a feature of concern with some online binary options platforms is that the total potential upside (i.e. a profit of $25.00) is less than the total potential downside (a loss of $100). In many cases the payout structure is on average weighted in favour of the seller. The total amount you could expect to receive if you guess correctly is less than the amount you will lose if the option expires.

In other words, the house always wins.

Some binary options are legitimately sold in regulated exchanges and can be used by sophisticated investors and traders as a part of a complex options trading strategy. Other binary options are sold on the internet to consumers who may not understand the risks involved in this form of trading.

The US Securities and Exchange Commission has warned US based investors that that it has received complaints of fraud against websites that offer binary options trading.  In February 2015, ASIC raised concerns about an unlicensed binary options trader from Belize directly marketing to Australian retail investors. The trader did not have a license to operate in Australia. It appears that traders based in Cyprus continue to advertise in Australia.

Consumers should be warned that if you trade on-line with an overseas broker, Australia’s consumer protection financial regulation laws may not protect you.

Australian corporate law will only usually regulate entities that have a license to deal in or give financial product advice to investors in Australia. 

Even if a binary options trader is licensed in Australia, it is important for investors to understand these risks involved in this form of trading. If you are considering trading in binary options, spend some time think through the risks as well as the potential upside. Also consider the risks of dealing with an overseas online trader. Buyers beware! 

Find our more about our Financial Negligence services.

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