To many, the Binary Options sector appears to remain an unregulated free-for-all. However, the truth is much more complex and there is increasing evidence that the sector has entered a more mature phase when regulation drives product development.
The free eBook Regulation of Binary Options Brokers, which you can download from this site by clicking here, shows that there have been a huge amount of changes over the past couple of years.
In summary, there are three categories of offerings available in terms of the regulation.
Unregulated OTC Brokers
The first category comprises the offerings provided by unregulated brokers. These are all offering what are often called ‘European-style’ Binary Options where the outcome for the trader is either a loss of the stake or a win that is equal to a known percentage of the stake.
There is a simple rule that traders should follow in respect of this class of offering: Don’t have anything to do with an unregulated broker.
It doesn’t matter how good their site looks or how good is their advertised service. If you deal with an unregulated broker you are taking on risks that you don’t need.
These types of options are often called OTC (over the counter) Binary Options. However, there are many brokers offering OTC options that are regulated.
Regulated OTC Brokers
The main source of this regulation until recently has been the CySEC in Cyprus. This is changing and other countries, principally the UK, Malta and Australia are beginning to regulate OTC brokers.
There is plenty more on this type of regulation in the free eBook.
OTC options are illegal in the US. So, if you are a US resident and you see a regulated broker offering you an account to trade OTC options then they are breaking their license.
Again, if you decide to trade under these conditions you are taking on unnecessary risks.
SEC Regulated Brokers
The third class of Binary Options are exchange traded, or US-style options. These retain the all-or-nothing outcome, but the payout is always either 100 or zero. The entry price varies depending on the market.
In this case, the trader buys a number of options depending on their price and the trader’s risk tolerance. In this respect, their format is somewhat similar to mainstream financial products.
Instead of a payout ratio, the broker earns money through a spread between the put and call prices that are offered and the broker also has the option to carry some trading risk on which a return may be earned.
The big benefit of these options is that they are regulated by the SEC in the US. Their pricing is deemed to be more transparent and it is believed that there is less of an incentive for inexperienced trader to place too much at risk.
However, they are not as easily accessible as the OTC options for traders with very small accounts since they may be priced anywhere between $1 and $99 per contract – in theory at least. The upside is that this may be a deterrent for very inexperienced traders.
Is it True that Regulation Drives Product Development?
Regulation has begun to have an impact on offerings. In summary, there is an incentive for OTC brokers to reformat their platforms and offerings to comply with the SEC requirements for exchange traded options.
They need to do this if they are to be regulated in the US and a number of the most high profile brokers who grew on the basis of OTC offerings are now doing this. Most still offer European-style options where these are legal, but there is a definite shift happening.
This move has also received a boost over the past year due to the decision of the Japanese regulator to introduce domestic regulation based on the US-style options.
The implication is that a broker that wishes to trade in the lucrative Japanese market with domestic regulation will need to offer exchange traded options. There is good reason to expect that having this regulation would also confer credibility to operate in other Asian countries where growth in these products is expected in coming years.
Regulation Needs to Strike a Balance
It’s not a done deal of course and there is also the possibility that other Asian countries might offer somewhat more flexible OTC regulation. As a result, the two products are likely to be available.
This also poses a challenge for regulators. There is no doubt that there is a real need for regulation to catch up with the sector.
However, the strict approach of the SEC in the US has meant that some OTC business has been driven underground. Unregulated brokers or brokers with regulation who break the terms of these license have certainly flourished.
There’s an old saying that bad money drives out good money. In economics it’s known as Gresham’s Law.
It’s also applicable to regulation. If regulations are too strict then there is a real incentive to operate outside the system.
This incentive is even stronger where there are two systems operating with sufficient confusion or lack of knowledge among consumers that they fail to perceive the risks associated with providers operating within the more flexible regulations.
Recently, the regulators seem to be striking the required balance. There is no better evidence of this than seeing OTC brokers beginning to offer exchange traded options in areas where these options only are regulated.
When regulation drives product development then the sector is maturing. Now we need more widespread regulation.
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