Something that has been on our radar screen for awhile is a concept and an investment vehicle called a binary option. A binary option is a type of option where the payoff is either some fixed amount of some asset or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The cash-or-nothing binary option pays some fixed amount of cash if the option expires in-the-money while the asset-or-nothing pays the value of the underlying security. Thus, the options are binary in nature because there are only two possible outcomes. Binary options are usually European-style options.
For example, a purchase is made of a binary cash-or-nothing call option on XYZ Corp’s stock with a strike price of $100 with a binary payoff of $1000. Then, if at the expiration date, the stock is trading at or above $100, $1000 is received. If its stock is trading below $100, nothing is received. Therefore, it is very easy to calculate your reward to risk ratio. So, why have we never put out any signals for a binary option? If you refer to the SEC’s investor.gov website you will learn that:
“Some binary options are listed on registered exchanges or traded on a designated contract market that are subject to oversight by United States regulators such as the SEC or CFTC, respectively, but this is only a portion of the binary options market. Much of the binary options market operates through Internet-based trading platforms that are not necessarily complying with applicable U.S. regulatory requirements. The number of Internet-based trading platforms that offer the opportunity to purchase and trade binary options has surged in recent years. The increase in the number of these platforms has resulted in an increase in the number of complaints about fraudulent promotion schemes involving binary options trading platforms.”
Even though “some” of the platforms do have the oversight of the SEC or CFTC, none of the major exchanges list them or they have little to no open interest. The fraud or illiquid nature of the product makes it impossible to implement for the class but is a very interesting academic lesson.
