Binary options are quickly becoming a good first port of call for new traders who would like to try trading options but are afraid of the risks presented by the risks of raw derivatives trading. While binary options have been available for some time in Europe, they have only recently begun to take hold in the US market.
Binary options allow traders to only profit from a specific outcome – will a particular market be above or below a specific level at a specific time? A simple example might be the closing price of the S&P 500. A traditional binary option will pay out if you are correct, and you will lose your money if you are wrong. Apart from conventional markets, binaries also allow traders to take a view on economic events – what will the next jobless report look like, or the next non-farm payrolls figure?
But, the important point to bear in mind here: traders of binary options only lose their initial stake if they are wrong. There are not the same risks as margin trading in forex, or with CFDs, where you can lose more money than you put up.
The market in binary options has come a long way since it was first launched at the start of the last decade. In the US, the SEC and CFTC, two of the main financial regulators, finally decided to act as it became increasingly obvious that frauds were being perpetrated by offshore brokers. They decided the time had come to bring the market onshore, and insisted that binaries should be traded only on regulated exchanges.
This may well have been the shot in the arm that the binary options market needed: now traders can take binary options positions on an exchange. This brings with it numerous benefits beyond the limited risks.
Binary options exchanges match buyers and sellers – the trader’s counterparty is anonymous. Traders from all over the world can trade against each other, and traders can act as market makers. It is a revolutionary approach.
The leading binary options exchange in the US is Nadex: a CFTC-regulated financial exchange, and the North American unit of IG Group.
“Trading on an exchange, you have much more visibility on price discovery,” says Dan Cook, Director of Business Development at Nadex. “Traders can see the price of underlying CME contracts which support the prices of the binaries they are trading.”
Nadex calls its clients ‘members’, and plays host to traders from 49 countries, although most are US-based. Trades can take positions on a wide range of markets, including stock indices, forex markets, commodities, economic events and even Bitcoin. There are over 5000 hourly, daily and weekly contracts traded six days a week.
Unlike larger futures and options venues, Nadex has been structured to make it a more level playing field for retail traders. For example, all traders must use the same desktop or mobile interfaces. There is no high frequency trading, or special privileges granted to proprietary traders.
Cook estimates that the bulk of Nadex members are retail traders. Position limits have been deliberately set low, at $100 per contract, with a total limit per member of 2500 contracts. “We’re not interested in the bigger traders,” he says. “We want to provide a venue that is safe and secure. We want to avoid the situation that CFD traders face, where you can easily lose more than your stake on the back of a single event. You know in advance what your maximum possible loss is, and hence can limit your risk.”
A former trader himself, Cook has seen how long it can take new traders to get used to proper risk management with derivatives. He says many new members only depositing between $500-$1000, and trading with that until they get used to binary options and the possibilities of exchange based options trading. Not only that, but Nadex members can also keep their demo account open indefinitely. It is a shrewd move for an exchange that is rapidly carving out an enviable niche in the online US trading market.
Apart from being a regulated exchange – which sets it apart from the offshore binary options brokers – Nadex offers a wider range of contracts and markets. Members don’t have to hold binary options to maturity either: this is an exchange, not a brokerage, so it is possible to sell a contract on.
Order fees on Nadex are on a per side basis, at 90 cents per contract, capped at 10 contracts. In the money settlement fees are 90 cents, with no fee if you are out of the money. If you exit before the contract expires, you also pay 90 cents.
Binary Options look like an extremely interesting proposition for beginner traders who are looking to move from stock trading to other markets. The risk limits and the regulated nature of the exchange, coupled with the fact that you are not trading against your broker, makes for a solid first venue for investors wanting to cut their teeth in the options market.
Adds Cook: “Neither Nadex as a firm, nor any Nadex employees take positions in their markets – members are trading only against other members, with total anonymity.”