What is a Binary Option?
A conventional binary option pays a fixed amount if a condition is true at expiry, and pays you lose your entire stake if it is false. For a conventional binary options, there is only two possible outcomes: profit the fixed amount or lose the entire stake. That is why they are called binary.
The most common type of conventional binary option asks whether an underlying asset (e.g. a stock) will be above (or below) a certain price (the strike price) at the time of expiry. It is only the price at expiry that is important. If you purchase an “above” binary option and the asset price is above the strike price at expiry, you get paid the pre-determined amount. You do not get paid more if the asset price is far above the strike price. If the asset price is not above the strike price, you lose the entire wager. You do not get to keep a fraction of the wager just because you were right about direction and the asset price climbed very close to the strike price.
With this type of conventional over/under binary option, you typically get paid in the 70%-90% range if your prediction comes true. You know in advance, before you purchase the binary option, how much it pays.
Visit https://www.binaryoptions.net/ If you want to learn more about the basics of binary options before reading the rest of the text. It will require a basic understanding on binary options.
Expected Value
The all-or-nothing design of the conventional binary option turns “almost right” into zero. Two trades with identical direction and similar but not identical strike price can produce opposite outcomes because the final print landed one tick on either side. That sensitivity lowers the signal-to-noise ratio and raises the share of variance explained by microstructure rather than by a trader’s thesis.
At some trading platforms, quotes are shown on a 0–100 scale. Buying at 42 and settling at 100 yields 58 before fees. Buying at 42 and settling at 0 loses 42.
Let ppp be the true probability of finishing in the money at expiry. Let BBB be the buyer’s entry price and SSS the seller’s entry price where B = p · 100 + Δ and S = p · 100 − Δ. Δ captures spread and fees. The buyer’s expected value per contract is:
E[P&L] = p · (100 − B) + (1 − p) · (0 − B) = 100p − B = 100p − (100p + Δ) = −Δ
Even if the buyer estimates ppp perfectly, the expectancy is negative by the wedge Δ. To break even, the trader must forecast ppp better than the market and overcome Δ consistently. Short expiries raise Δ relative to the small edge most retail users can generate, so the hurdle is rarely met.
If you lose 100% each time you lose, but only get paid 90% each time you profit, being right half of the time is not enough to break even. You need to be right more than that, since the odds are stacked against you, to benefit the trading platform.
Consider two users placing 100 trades each at ten-minute expiries on liquid FX pairs, entering at prices implying 50% fair odds. With a typical wedge of 3 points (buy at 51.5, sell at 48.5), the expected loss per trade is 1.5 points for buyers and 1.5 for sellers before any behavioral mistakes. Over 100 trades at a $10 stake per point, the structural drag is roughly $150 per side, excluding slippage and widened quotes during news. A small edge in prediction accuracy (say 53% true odds) still fails to overcome the wedge unless entry/exit timing is unusually precise. Few retail users maintain that precision.
Timing Risk
Short windows make fills and settlement highly path-dependent:
- Quotes widen near data releases, venue opens/closes, and into the final seconds before expiry. A larger wedge reduces fair odds for both entries and early exits.
- Platform latency and reject logic can move a trader from a displayed price to a worse fill. The difference is small in points but large in expectancy because the payoff is digital.
- Settlement relies on a chosen benchmark feed. Minor differences between that feed and public charts at the decisive tick create disputes that customers struggle to document without tick-level records.
Early Exit
A major downside with binary options is that you can not use stop-loss orders and take-profit orders. Once you have purchased a conventional binary option, you have to own it until it expires, and there is no way to lock in a profit early to cut your losses and get some of your stake back. Stop-loss and take-profit orders are extremely important tools for risk-management in conventional trading, and binary options traders are left without them.
Some trading platforms have listened to these complaints and began offering early-exit features on some of their binary options. Typically though, early exit only becomes available under particular circumstances. Also, it is priced by the platform and rarely symmetric, so traders pay more to get in than they receive to get out at the same notional probability.
Incentive Conflicts and Commercial Model
In the world of binary options trading, your broker (the trading platform) is usually also your counterpart in each trade. Platforms internalize risk and selectively hedge, both earning the wedge and gaining when clients lose. When the trading platform is also the counterparty, commercial success rises with client turnover, not with client profitability.
With that said, your broker being your counterpart is not unique to the world of binary options trading. It is actually very common that inexperienced traders (conventional trading, e.g. stock trading) start out with brokers who are also their counterpart, because these brokers tend to accept low deposits and permit micro-sized trading. However, with conventional trading, a retail trader can pick a market maker brokers who is regulated and supervised by a strict financial authority that enforces strong trader protection rules to mitigate the potential problems that can arise when this inherent conflict of interested between broker and trader is present.
Behavioral Amplifiers
Platform choices heighten known biases:
- Binary options marketing tend to emphasize speed, simplicity, and high headline payouts “in minutes,” while small print governs things such as early-exit rules, bonus clawbacks, and turnover requirements tied to withdrawals.
- Frequent outcomes spur “martingale” doubling after losses, which looks effective until a streak wipes the account.
- Short clocks reward action over selectivity and make post-trade review harder because each bet blends direction and timing error.
These effects tend to be strongest among inexperienced traders and those trading when attention is fragmented and review time is scarce.
Alternatives to the Binary Option for Retail Traders
While all derivative products carry risk, there are derivatives that provide better control and transparency than binary options, e.g. vanilla options, Contracts for Difference (CFD), and futures contracts (including micro-sized futures contracts). Note: CFDs are not permitted for U.S. retail traders.
With a conventional binary option, the payoff vs. move is fixed. The exit flexibility is either zero, or prohibitively priced by the platform. All costs are bundled into the stake vs. payout ratio. Conventional binary options are extremely sensitive to last tick, and they are not well-suited for hedging strategies.
If you instead use a vanilla option (let´s say a classical call or put option), you get a payoff that scales with move size, and you have a lot of flexibility to close the option early or adjust your exposure size. You pay the so-called premium when you purchase the option, but you must also take any spread and commission into account, and these will vary depending on broker and circumstances. The vanilla option´s sensitivity to last tick is moderate. Vanilla options are frequently used for hedging strategies.
Just as with the binary option, a Contract for Difference (CFD) will typically have your broker as your counterpart, but the payoff vs. move size is linear, and you are free to close the CFD at any time. It is important to take any spread, commission, and swap fee into account, and they will vary depending on broker and circumstances. The sensitivity to price movement is continuous. Straightforward hedging.
For futures contracts, the payoff vs. move size is linear, and you are free to close out the contract at any time. It is important to include fees such as any exchange fee and clearing fee when you evaluate the suitability of a trade. The sensitivity to price movement is continuous. Straightforward hedging.
Example: If you predict that the price of an asset will drift higher in the coming hours, a call vanilla option, or going long in a CFD or micro futures contract, will give you exposure to this movement, while also aligning payoff with move size and allow mid-course corrections.
What are vanilla options?
The most basic and commonly traded financial options are known as vanilla options. (The term does not denote that they are commodity options based on the price of vanilla. In English, the term vanilla is often used to denote something that is plain and ubiquitous, just like vanilla ice cream.)
A vanilla option gives the option holder r the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) on or before a specific date (the expiration date).
If you buy a call vanilla option, you get the right to buy the underlying asset. Traders buy call options when they think the price of the underlying asset will go up. If you buy a put vanilla option, you get the right to sell the underlying asset. Traders buy put options when they think the price of the underlying asset will go down.
The price you pay when you purchase a call option is called the premium.
If you decide to use the option (to buy or sell the underlying), it is known as exercising the option. An American-style option can be exercise at any time until the option has expired. A European-style option can only be exercised on the expiration date.
Example:
- You buy a call option on 100 shares in XYZ with and pay a $5 premium. The strike price is $100 and this is an American-style option that expires 30 days from now.
- A week later, you see that the sock price for XYZ has gone up to $120. You decide to exercise your right to buy 100 shares for $100.
- For 100 shares where the market price is $12,000, you pay only $10,000. Your profit (before trading costs) is $2,000 minus $5 = $1,995.
Vanilla options are traded both on exchanges and over-the-counter (OTC). Vanilla options traded on exchanges are highly standardized.
What are CFDs?
A CFD is an agreement between a buyer and a seller to exchange the difference in the price of an asset from the time the contract is opened to when it is closed. If you think the underlying asset will go up, you pick a buy-CFD (go long). If you think it will go down, you pick a sell-CFD (go short). When you close the position, you profit from the price difference if you predicted the correct price direction. Otherwise, you take the loss.
Example:
- 1.) You open a CFD to buy Tesla at $250. (You go long.)
- 2.) Tesla goes up to $270.
- 3.) You close the position.
- 4.) You profit $20 per share (excluding fees, spreads, leverage costs, etc).
On retail CFD trading platforms, your broker is typically also your counterpart in the trade. The CFD is not an instrument traded with other traders on and exchange, or even in an OTC market place. Each contract only involves you and your broker.
CFD brokers almost always offer leverage, but using leverage is optional. In practice, most retail CFD traders use at least some level of leverage since it reduces the upfront capital required. When you use leverage, you are essentially borrowing money from your broker, and risking it. Leverage will amplify both losses and profits. In several countries, law makers have capped how much leverage CFD brokers are allowed to give to retail traders.
Note: Retail CFD trading is not permitted in the U.S.
What are futures contracts?
A futures contract is a standardized legal agreement where one party is obliged to sell and other party is obliged to buy an underlying asset at a predetermined price on a set future date. Futures contracts are highly standardized and traded on exchanges such as CME, NYMEX, Eurex, ICE Futures U.S., and ICE Futures Europe.
Unlike the vanilla option, the futures contract is binding for both parties. Futures contracts has their foundation in the need to manage risk when market prices are volatile. A wheat farmer can use a futures contract to lock in the price of wheat long before harvest, and a company that produces crackers can use a futures contract to be sure what they will pay for wheat the next time they need to make a large purchase. Traders use futures contracts for pure speculation, and there are also hedgers who use futures contracts to manage risk in investment portfolios.
A futures contract can be settled either in physical delivery (rare in financial markets) or in cash. Many futures contracts are canceled out (or “closed”) before expiry. In fact, the majority of futures traders close their positions before the expiration date.
Only a fraction (called margin) is needed to control the full contract, which means this is a leveraged product. Example: Let’s say you want to trade one crude oil futures contract. The contract is for 1,000 barrels of oil. The current price of oil is $85/barrel, so the total contract value is $85,000.
But you don’t need to pay $85,000 to enter the trade. Instead, the exchange might require a margin of just 10%, i.e. an initial margin of $8,500. Initial margin is the amount of money you must deposit to open the position. Maintenance margin is the minimum balance you must keep to hold the position, and this level can change throughout the lifetime of the contract. If your account falls below this, you get a margin call. When you have an open position, profits/losses are calculated daily and added/subtracted from margin.
Consumer Protection Concerns Regarding Binary Options
Examples of common patterns seen across complaints filed against retail binary options brokers online:
- Turnover-tied bonuses that delay withdrawals or cancel them retroactively. The turnover is often very high, and the terms and conditions opaque or buried in fine print when the trader accepts the bonus.
- Opaque settlement where benchmarks, timestamps, and rounding rules are hard to find or verify.
- Aggressive promotions aimed at first-time users, with VIP tiers pushing higher stakes to unlock perks. Assigned “account managers” employing high-pressure sales tactics to encourage larger deposits and more frequent trading.
- Inadequate disclosures around the share of losing accounts, the true impact of the wedge, and early-exit pricing.
- Counterparty and custody issues, where client funds are mingled with operating funds, and venue failure results in total loss of account balance.
- Platform outages and platform freezes.
- Weak account protections which increases the risk of unauthorized activity.
- Enormous leverage offered to inexperienced retail clients.
- Unpredictable payout caps
- Failure to disclose company information, client money segregation routines, and custody information.
Measurement Framework for Supervisors and Platforms
Examples of information that is often lacking on retail binary options platforms online:
- Client-level expectancy after all costs over rolling windows by product and expiry bucket.
- Distribution of outcomes by distance to strike in the final minute to quantify last-tick sensitivity.
- Share of volume in sub-15-minute expiries and correlated complaint rates.
- Average wedge (Δ\DeltaΔ) by product and time of day to benchmark effective house edge.
- Withdrawal latency and failure rates segmented by account tenure and bonus usage.
- Which legal entity holds client funds and which regulator supervises it.
- Exact benchmarks and timestamps used for settlement and whether raw ticks are archived and shared on request.
- Full fee schedule including early-exit rules and how bonus terms affect withdrawals.
- Clear warnings and audited loss-rate disclosures, including historical loss rate by retail cohort and by expiry bucket.
- Evidence that quotes and wedges tighten during liquid windows rather than widening near every decision point.
Publishing these stats, even in aggregate, would allow for a better informed independent review.
Guidance for Retail Users
Inexperienced traders who wish to engage in binary options trading despite the high risk can take certain steps to put themselves in a somewhat better position.
- Traders should avoid short-expiry binaries entirely. Longer expiries to lower noise dominance and reduce last-tick sensitivity.
- Traders should set session loss limits, weekly loss limits, and monthly loss limits, and threat these as hard stops.
- Traders should log every trade with the displayed wedge at entry. If you can’t keep that log for a month, the product is too fast for your routine.
- Traders should only allocate a very small portion of their total savings/investment/trading budget to binary options. The first steps should be to build an emergency fund of savings, and make regular contributions to a low-cost core investment portfolio.
- If a trader is interested in derivatives, learn about vanilla options, CFDs, and micro futures too, instead of diving right into binary options. Knowing about the different choices available will help the trader make a more well-informed decision.
Conclusion
Binary option platforms have a tendency to market the high speed and fixed-payout in a way that hides the structural disadvantage. The wedge turns fair odds into negative expectancy, all-or-nothing settlement punishes near-misses, and short clocks amplify impulsive behavior in traders, especially inexperienced ones. Platform incentives often point away from user success. While several other derivative instruments give control over exits and yield payoffs that reflect the size of a move, binaries force a flip on a single tick.
Appendix A: Quick Math for Review Teams
- For an at-the-money digital call under Black–Scholes with volatility σ, time t, and risk-free rate r, the fair value is approximately: e−r t N(d2) · 100 Any quoted buy price B above this fair value equals the fee-adjusted wedge; the same applies to sells below fair value.
- Sensitivity near expiry As t → 0, small changes in the underlying cause large changes in N(d2), making price jumps translate into stark shifts in quoted probability. This is why last-tick issues dominate outcomes for short clocks.