ESMA’s product intervention measures in relation to CFDs and binary options offered to retail investors, 27 March 2018, ESMA71-98-125, p. 3, 4
What are binary options?
- Binary options enable you to get a predetermined fixed pay-out if an underlying asset meets certain predetermined conditions, generally within a particular time-frame.
- A common form of a binary option is that you receive a fixed pay-out if the price of the underlying, such as an exchange rate, a share or a commodity, reaches a specified level. For example, a binary option might be issued at 1100 offering a return if the price of gold has increased by 1500 the same day. If the price of gold is lower at 1500 than it was at 1100, the investor loses the amount invested.
- Due to the characteristics of binary options, retail investors on average lose money with these products and there is no clear alternative investment purpose for them (e.g. hedging of risk).
- All types of binary options offered to retail investors are included in ESMA’s measure. For example, sometimes binary options are known as binary bets. This is because they are highly speculative and the pay-out is quoted in a similar way to fixed-odds bets, such as those on sporting or political events.
- Binary options are distinct from other options. Unlike binary options, other options do not provide for a fixed pay-out. Instead, the return from the option falls within a continuous range. Common examples are call or put options, which are sometimes called ‘vanilla’ options. For instance, a put option is worth more the further the price of the underlying asset falls below the strike price. For this reason, non-binary options such as vanilla options can be well-suited for use in hedging another investment.