IDENTIFYING THE GENESIS AND PROJECTING THE FUTURE …...Identifying the Genesis and Projecting the...

IDENTIFYING THE GENESIS AND

PROJECTING THE FUTURE OF THE BINARY OPTIONS INDUSTRY

A Forex Magnates™ Research Paper

The Evolvement of a Unique Class Of Options Under The Watchful Eye Of Stringent International Regulators

Identifying the Genesis and Projecting the Future of the Binary Options Industry

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IDENTIFYING THE GENESIS AND PROJECTING THE FUTURE OF THE BINARY OPTIONS INDUSTRY

The binary options industry as we know it began evolving six years ago, when Israel‐based etrader became the first broker to launch a retail binary options product which would later open the door to its global brand anyoption.

In 2008, etrader/anyoption developed its own platform to deliver an end product, a year before other potential competitor binary technology platform providers emerged, the first of which were Markets Pulse, SpotOption, TechFinancials and Tradologic. By late 2010, they had all delivered their definitive products to the market, and currently there are over ten technology providers of binary options trading platforms.

But while technology providers adopted a strategy which highlighted the tech aspect and began developing their platform solutions for 3rd party white labels, the likes of anyoption pursued a contrasting business model to utilize its platform as a complete in‐house package. Other technology providers followed suit, and the number of white labels increased steadily in an unregulated environment free of constraints.

Any form of regulatory attention directed at the binary options industry could prove to be a positive development in the long run, bringing additional legitimacy to the product and providing governments with an incentive to tax the business and open a new revenue stream.


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In retrospect, as is the case with any new product, the regulators were completely unaware of the nascent binary options industry. Almost all the companies operated in offshore zones and hadn’t even considered the inevitability of a financial services license. Their marketing strategies were good enough to secure a few years of virtually undisturbed operations as unregulated businesses, plausibly related to the financial industry.

In 2012, after a couple of years of heady success, regulatory attention began zooming in on the initial providers after a barrage of complaints from end users. While the amounts on the agenda were small, they positioned the industry fast on the global regulation radar.

Regulatory Overview The French market was the first area that was impacted by the unhappy client backlash and the consequential regulator probe. While the French financial regulator (Autorité des marchés financiers) sent out slow moving feelers to identify the companies that were operating illicitly on the local market, the Cyprus Securities and Exchange Commission (CySEC) took a different course of action, becoming the first regulatory body that actually focused on researching binary options companies after persistent lobbying from local financial licensing firms.

The main reason was that several binary options firms were already based in Cyprus, so the overall legitimacy of the services provided from the island warranted CySEC’s attention.

The greater part of these firms still market their product as financial services, as opposed to the other option of acquiring a gaming license (such as the one issued in Malta or Gibraltar) and marketing the trading tools as fixed odds bets. These mostly fall under gambling regulations as is the current legal classification under U.K. law.

The regulatory landscape in the U.K. is currently on track for an overhaul; the government recently proposed a consultation paper which will recommend the exclusion of binary options from the 2005 Gambling Act, and regulating them as financial products under the U.K.’s Financial Conduct Authority (FCA). To date, the financial regulator has defined binary options as a fixed odds bet, which doesnʹt qualify it for financial regulation.

Meanwhile, the product will be exempt from the regulatory requirements listed in the new 2014 Gambling Act, as this would require all overseas binary options operators to obtain an operating license from the U.K’s Gambling Commission. The publication of the consultation paper has been scheduled for January 2015.

Until CySEC took this matter under consideration, there was no supervising body in the European Union (EU) regulating the binary options sector. Once CySEC announced its policy change, it officially became the first global financial regulator to recognize and regulate binary options as financial instruments, and as such, they were finally accorded a legitimate status.


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Regulation History If we endeavor to put developments across the industry into perspective, it was most notably the U.S. government’s lawsuit against Banc De Binary which cemented the stance made by U.S. regulators. In June 2013, Banc De Binary was charged with violating the U.S. Commodity Futures Trading Commission (CFTC) ban on offering commodity option contracts to U.S. customers for trading, as well as soliciting, accepting orders and funds, or confirming the execution of orders from U.S. customers, a practice which is illegal in the United States. Banc De Binary followed up with a corporate statement that all their U.S. services had been discontinued, to which the SEC responded in May 2014 with an “amended” charge to which Banc De Binary affiliate companies and the CEO had been added.

Any form of regulatory attention directed at the binary options industry could prove to be a positive development in the long run, bringing additional legitimacy to the product and providing governments with an incentive to tax the business and open a new revenue stream. However, this did not apply to the U.S. As the product’s marketing campaigns took off, it was subjected to stringent conditions which ruled that it had be traded on an exchange. This immediately discouraged 99% of the potential brokers from further involvement with the CFTC.

Almost all binary options operators accepting clients from the U.S. have made the decision to limit access. The long reaching arm of the U.S. authorities swiftly compelled the industry to self‐control its operations in the country. There are, however, a number of brokers that are still accepting U.S. clients, albeit on a much lower scale since the announcement of the Banc De Binary lawsuit. On the other hand, it would be very difficult for a country to limit access to binary options brokerages websites, as the ongoing cat and mouse game will persevere organically, parallel to the realization of new websites.

Up until now only NADEX (subsidiary of U.K. based IG Group) and the upcoming Cantor Exchange (joint project of Cantor Fitzgerald and TechFinancials) have taken the steps required for the operation of an exchange in the U.S. There has been some mention of projects which are in in preliminary stages of development, but details are scarce and their introduction seems very distant.

Shadowing the CySEC regulations determined in 2012 and the CTFC’s footmark in 2013, the Japanese Financial Services Agency (JFSA), implemented a stringent regulatory framework in September 2013 which defined clear requirements for the products brokers can introduce to the market.

Once the regulations were ratified, a substantial drop to $15 million per month in 2013 occurred as compared to the average $20 to $25 million generated per month in 2011. Of note is that after the regulatory changes were effected in Japan, a large portion of the local market which uses offshore brokers to trade binary options, could, according to our estimates, average half of the regulated volumes.


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Key Industry Trends According to the data collected by the Forex Magnates research team, deposits in recent years have been growing briskly and will continue to do so in light of the straightforwardness of the product, its growing popularity and clever marketing strategies that are aiming for the industry’s legitimization. Our researched data indicates that every $1 deposited is realized in 9-13 as much in trading

volumes. From a historical perspective, there has been a substantial growth of deposits since the industry took off in 2009. After this foundational year and subsequent stabilization in the following, global deposit volumes ex‐Japan (which will be addressed separately), have set the floor at approximately $5 million per month. As of 2010, the numbers have been doubling roughly per year: $5 to $15 million in 2011, followed by figures of $15 to $20 million in 2012 and approximately $30 to 35 million per month in 2013.

Source: Forex Magnates Research Department

2014 is no exception; per‐month estimates averaged deposit amounts of $75 to $90 million, with forecasts for 2015 and 2016 keeping the trend intact, albeit at a slower pace. Expectations for next year are for similar growth in nominal numbers to an estimate of $120 to $135 million per month, while in 2016, the market could come close to 25% of the size of the forex market, where typical per month deposits are estimated at $600 to $750 million.

As product awareness increased in Japan, the value of per month deposits peaked in 2012 at a rather robust monthly pace of $40 to 60 million before regulation was implemented. A shallow rebound followed in 2014 with the industry estimated to accumulate deposits of $20 to $25 million per month. The forecast for the Japanese binary options market is in the region of $25 to $40 million in 2015, and a gradual return to the previous highs of 2012 is expected as early as 2016.


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New, higher FX leverage requirements impacted the Japanese market in 2010, when the first round of maximum margin caps was enacted. Leverage was initially restricted to a maximum of 50:1, which led to activity on the binary options market spiking higher ‐ $5 to $15 million in monthly deposits throughout 2010. The second drop in leverage in the forex market to 25:1 did not affect the market materially as had been anticipated, and traders adjusted their strategies accordingly. The forecast rebound in binary deposits is based on the understanding of Fx volumes rebounding despite harsh regulatory restrictions, as indicated in the chart below:



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Regulatory Trends The entire industry is shifting towards regulation, and a divide will occur between those choosing to follow the route of gambling regulation and those who have a preference for financial services regulation. Alternatively, there are always those who prefer to operate without regulation, and therefore cannot provide complete transparency.

Following the recent focus of European governments to achieve extra revenue streams, principal countries such as Italy, Spain and Germany (in part), have decided to issue their own regulations and to charge gaming companies hefty fees. Other European countries such as the U.K. are planning to target binary options and delegate regulation from gaming to the financial regulatory bodies, similar to the regulatory environment in Cyprus.

As regulated gaming markets are too large to be ignored, the operators started filing their applications after a partial consolidation of the industry. For now, there is a general perception that offshore gaming licenses permit operations across most of Europe.

CySEC regulation can be passported to other EU member countries through MiFID (Markets in Financial Instruments Directive). According to the official stance expressed by the European Commission (EC), binary options are derivative contracts settled in cash, which makes them fall under the definition of financial instruments. Therefore, companies that offer investment services and activities with binary options are authorized as investment firms under MIFID.

The section of the MiFID directive which applies to binary options, covers the derivatives contracts rules listed in the current legislation. Binary options contracts fall within the list of contracts relating to prices of securities, currencies, interest rates, yields or other derivative instruments. According to the EC, binary options have the features of a derivative contract settled in cash.

There have been several debates whether binary options trading volumes and client assets should be reported to the official repositories

Of late, many affiliate websites have turned their attention to providing a comprehensive market forecast in combination with a set of chart reading strategies rather than the standard “get rich quick” binary options key phrase.


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established by European regulators. A spat between the Financial Conduct Authority and the rest of the EU countries has led to the exemption of all foreign exchange derivatives from reporting. However, according to current legislation, trades on other instruments such as commodities, indices and stocks must be reported.

The uncertainty concerning future regulatory trends is still significant, and the winner is nowhere in sight, be it gaming or financial regulation. Government intervention provides no guarantee, and it is entirely possible that companies will run with both forms of regulation until one of the paths proves to be adequately well‐structured and appealing to clients.

To date, gaming regulations are proving to be friendlier for binary options operators, and several industry insiders claim that the product is naturally inclining more towards gaming regulation, but as mentioned above, recent efforts by certain EU governments to reign in offshore gaming operators and for each to introduce their own unique set of requirements and fees, can make this already fragmented regulatory landscape extremely unappealing. The trends in financial regulation are quite the opposite, as once The Markets in Financial Instruments Directive (MiFID) was introduced, the entities could operate cross‐border, all over the EU. That said, financial regulation can be much stricter when compared to gaming regulation, which can pose a risk.

Trading Instruments

Binary options traders find foreign exchange markets extremely appealing. Whether this is due to the relatively established popularity of forex as an asset class for retail investors, or the fact that the currency markets are open 24/5 with some companies now even offering 24/7 trading on long term options, the result is that approximately 84% of total volumes are traded in forex pairs.

The second place is reserved for commodities, and this is mainly the result of gold trading. As trader activity patterns submitted by foreign exchange brokers indicate, gold is a particularly attractive asset for traders in Asia by cause of established cultural norms. According to the latest survey data from the World Bank, close to 20% of the savings of

The regulatory landscape in the U.K. is currently on track for an overhaul; a recently proposed consultation paper, will recommend the exclusion of binary options from the 2005 Gambling Act, and regulating them as financial products.


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Chinese households is held in gold ‐ another major point which illustrates the local market’s interest in the precious metal and its importance.

Indices are the next asset class which caters to binary options traders, and that too, is a major point of interest for retail traders. As is the case with pretty much any asset class, indices become attractive when stock markets become more volatile. However their current market share is rather small at about 6%, trailed only by individual stocks. Prices of shares of different companies comprise barely 3% of total trading volumes. There is increased activity during the earnings season, and additional risks can surface when binary bets are placed on stock prices around the company’s earnings dates and conference calls.

84%

7%6% 3%

Foreign Exchange

Commodities

Indices

Stocks

Binary Options Volumes



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Growing Industry Trends Signals and robots that define client trading strategy are widely available now, as traders are seeking to automate their strategies so that they can utilize real‐time and accurate market predictions. This corresponds to the relatively low financial market knowledge level of most binary options clients. While brokers and affiliate websites do provide educational materials, there is a huge demand for solutions such as trading signals and forecasts for future market behavior. It is imperative that brands dedicate ample educational resources for client retention purposes.

Of late, many affiliate websites have turned their attention to providing a comprehensive market forecast in combination with a set of chart reading strategies rather than the standard “get rich quick” binary options key phrase.

Clients with a shorter life span are likely to trade a shorter period of options, just like any other trade which expires in 120 seconds or less. While short expiry periods decrease the lifespan of some of the players, it increases it in different cases ‐ players who are using more than one option ‐ digital, turbo, touch and range have the highest player value for the brand. There is a clear distinction ‐ one type ‐ least value, two types ‐ more value, three and more ‐ depositors with the highest value.

Organizing tournaments is another emerging trend in the binary options space and is a top‐level retention tool. Participants are entertained by the games, and at the same time limit the risks to the broker as the risk exposure can be transferred to the peer participants, that is to say other clients. In such a mode of operation, the broker will be acting as ‘the house’ in a poker tournament.

A gaming‐styled product, similar to the foreign exchange industry models, has been introduced into the binary options arena. A number of players pool their money, and play against each other for a limited time frame. Some members of the financial industry have questioned if these products are purely financial, or designated solely for gaming regulation. This trend, which is picking up speed, could clearly impact the decisions of binary options brokers whether to choose gaming regulation or financial services status.

Platform Providers The platform provider industry is becoming more competitive with new players entering the market the past couple of years. There are five major platform providers on the market at present: Markets Pulse, SpotOption, TechFinancials, TradeSmarter and Tradologic, where SpotOption and TechFinancials have the biggest clients. The second tier includes BinaryStation, Finomaker, Hello Markets, Keystone/Playtech, Leverate, O‐systems and Panda.


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Dukascopy was the first of the major foreign exchange platform providers to enter the binary options industry as a technology provider. But their short time frame trade product can deter experienced binary options clients seeking longer term expiries and different games.

The move opened the door for direct competition from the Forex industry. But this meant that the lines became blurred for the various client category groups, with each instrument targeting the other in order to expand operational scope and future offerings. For now traditional forex clients don’t perceive any benefit to trading forex with binary options providers; rather, the opposite has more credibility. Therefore, several forex providers are offering binary options services via white labeling technology from the established players on the binary options market.

As with any industry, more competition in the binary options platform provider space is likely to lead to an improved end product. Smaller platform providers too can deliver market innovations by focusing on certain niches, inevitably changing big players’ business methods.

Conversely, many challenges are anticipated in conjunction with the increasing market saturation. A new and disquieting development for industry players that are specifically targeting the Chinese market is the emergence of copycat providers.

Main Risks Facing the Binary Options Market When the industry first appeared, price manipulation practices were the norm for clients that were starting to accrue large amounts of money. With the introduction of proper regulation, these malpractices have been gradually declining. So as to maintain rapid growth, the industry has to keep in check the methods it applied to its own risk management which is associated with losses against clients. There is an absolute conflict of interest between binary options brokers and their clients, as one party’s losses are the other party’s gains. However, over the recent twelve months and in the predictable future, brokers will have to ensure that their losses are limited, and will be compelled to focus more on methods such as introducing position

The NYSE’s entry into the market will most likely spark additional interest in the product.

If any of the market participants manages to come up with a product attractive enough, there is a very high potential for growth on the U.S. market.


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limits, dynamic risk management tools and introducing a spread in a similar manner to the forex industry rather than price manipulations. This will provide the broker with an improved entry price and at the same time, provide transparency to the client.

If a broker’s exposure to a certain market direction is larger than the other, dynamic price levels will be introduced, which differ automatically from the market (or expiry) price. The client will observe that the market is skewed, and will have the choice whether to enter the market or not. In malpractice cases ‐ the client would place his trade when seeing one price, but instead will have the order executed at a completely different level. As the industry gains traction, manipulative price behavior must be eliminated from the equation and it will happen quickly ‐ especially in the case of companies with a financial product license.

An illicit operator, or provider, can have a negative impact on the industry as a whole. The once lucrative French market is now difficult to operate in due to the negative sentiment which various malpractices instigated. Regardless of which regulatory environment the industry will adhere to, unambiguous rules will provide much less room for these operators to maneuver in.

The second principal risk posed is the oversaturation of the market. A broker does require a proper marketing budget to introduce a new business. Industry sources are confirming that the minimum budget which a new brokerage would require for marketing is at least $300,000, and the strategy must be supplemented by a comprehensive knowhow of driving web traffic. According to estimates, current acquisition costs per client for a brokerage average $200 to $450.

Many new brokers claim to have a good understanding of the binary options, because they have previous professional experience. Other market entrants might have secured a database that will facilitate efforts, but that is rarely the case. There is a need for knowledge of the online marketing space, as proved by recent examples of shifting strategies for binary options to the offline marketing space, ergo commercial sponsorship

24option recently partnered with major Italian football club Juventus, while EZTrader has signed exclusive partnership deals with German club Bayer Leverkusen and Dutch team Feyenoord Rotterdam. Both brands are CySEC regulated and have engaged in substantial spending efforts to drive their brands into the real world, concentrating on the relatively gambling friendly football watching public which is already betting on sports games.


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The Geographical Factor Europe, the largest binary options market since inception, comprises 50% of the client base. Russia and China are the next big growth engines, and there are some indicators that the latter could surpass Europe in the near future. Russian volumes have been growing steadily with binary options products gaining popularity and compensating for fairly flat volumes across Europe in recent months. Further regions experiencing rapid growth include the rest of Asia, with India making fair headway into the business lately. Africa is ranked next; there is substantial growth potential in the continent, but that is a long term prospect at present. The South American market has been strictly cramped by rigorous restrictions on payment providers, underdeveloped financial trading infrastructure and complete lack of regulatory framework even for more veteran trading products such as FX.

There are very few operators offering their services in Australia and the market has huge growth potential, despite its current negative reputation, due to some unregulated companies targeting the market aggressively. Despite the existing regulatory framework, for the time being, there is no legal framework for the Australian Securities and Investments Commission (ASIC) to enforce stringent restrictions on clients dealing with foreign regulated binary options brokerages operating in the country.

According to Forex Magnates Research resources, the pick-up in volatility in September drove increased volumes to the forex market, which meant that the binary options trading desks have also benefited from the increased activity in trading currency options.


Geographical Distribution Estimate


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The big difference is that the operator of the exchange is essentially facilitating the counterparts that engage in transactions on it in an unbiased manner.

The exchange holds the balances of the accounts as per U.S. regulations, and collects a small fee in return for facilitating transactions. Both parties participating in the transaction assume joint responsibility for the trade going sour. The U.S. model brings both transparency and anonymity to the market, however counterintuitive it may sound. The transparency aspect is that the exchange is settling a third party market, in contrast to serving as a counterpart as is the case with most offshore binary options brokers. The anonymity quality of the trade is demonstrated by the fact that there is no information about the positioning when a trade is settled ‐ there is no telling whether a market player is entering or exiting a position.

On the whole, exchange type binary options are a lot more cerebral, and opening an exchange account is a protracted and overly bureaucratic process.

Apart from NADEX which is already an established local market player, Cantor Exchange is returning to the U.S. binary options market in the near future in collaboration with TechFinancials. An offering from the New York Stock Exchange is also in the works with the purported Binary Return Derivatives (ByRDs) contracts. These are based on ETFs and single stocks, and are exchange traded binary options contracts. There are two types of ByRDs: Finish High and Finish Low ByRDs, which are similar to the high/low options in the conventional binary options world. As opposed to NADEX which operates under CFTC’s umbrella, the SEC regulates the NYSE’s solution.

Having the NYSE participate in this market can dramatically alter the perception towards the contracts and generate additional interest in binary options trading. Increased competition between players on the American market can result in various type contracts.

Trading volumes at NADEX have grown substantially in recent years as at first the company realized 2,000 to 3,000 trades a day in contrast to current daily reports indicating an average of 20,000 trades.

This can only be the start of growth in the tough U.S. regulatory space, as the number of companies providing the trading tool for is forecast to increase from one to three players. As mentioned, the NYSE’s entry into the market will most likely spark additional interest in the product. If any of the market participants manages to come up with a product attractive enough, there is a very high potential for growth on the U.S. market.

The CFTC has made it clear to all parties involved that such contracts are to be traded on an exchange. Enter the IG Group with their U.S. subsidiary NADEX which operates as such an exchange.

The U.S. Binary Options Market After the implementation of the strict binary options exchange standard mandated by the CFTC, there was a considerable depreciation of client targeting strategies in the U.S. Some brokers still claim to be “U.S. friendly”, but clearly not as many prior to the regulatory overhaul. Close to 80% of certain brokers volumes of certain brokers were sourced from the U.S. at the height of the unregulated market reign. Currently most brokers, even the unregulated ones, are unwilling to take on the risk that U.S. clients represent.


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The Popularity of Binary Options An assessment of recent Google Trends data indicates that global interest in binary options is vibrant and portrays a rapidly growing market. After the search term initially plateaued in 2010, the interest picked up materially from 2011 through to 2013. The past 12 months have seen some consolidation, but data for September indicates a new record high interest in ‘binary options’ as a search term, which is quite probably linked to rising volatility on the foreign exchange market. According to Forex Magnates Research resources, the pick‐up in volatility in September drove increased volumes to the forex market, which meant that the binary options trading desks have also benefited from the increased activity in trading currency options, which is by far the most interesting asset class for binary options traders at present.


While it is undoubtedly valuable to compare forex and binary options, there are many differences ‐ if we look at a comparison between ‘binary options’ and ‘forex’ Google Search terms, the former still makes up only a small fraction of what ‘forex’ searches constitute. This is good news for the industry only, in view of the substantial potential for future growth. With the relative simplicity of binary options trading when compared to spot forex trading, the growth numbers can only be higher when compared to the growth trends of ‘forex’ searches.


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On the other hand, as binary options are not commonly defined as an investment tool, (despite marketing efforts), the likelihood of high value deposits in this market is slimmer than in foreign exchange trading.

Recap

While additional regulation outside of the U.S. and Japan can initially impede growth numbers for the industry,

it will take the regulatory bodies a very long time before they can implement additional measures. In addition, a

sizeable chunk of growth is likely to come from relatively unregulated markets such as China, Russia, the rest of

emerging Asia and Africa. While there are some offshore brokers working in Japan, the trend for regulation that is

quietly taking shape could encourage clients to use legitimate operators. That said, there is no such inclination at

present, and a sizeable section of offshore‐operating companies are creating a substantial market.

Along with Canada, mainland European regulators have been the most aggressive in warning against

unregulated brokers. Italy set a precedence when the Judge of Rome, on the order of the Public Prosecutor, and

following the request submitted by Italian regulator Consob, directed Italian ISPs to block numerous binary

options sites.

There is some pressure from the larger firms to clean up the sector. Consequently, brokers are becoming regulated

to avoid being blacklisted or fined.

Reflecting on the post regulatory U.S. and Japanese experience, we can expect a rebound that can lead to

additional interest in the product and after an initial pick‐up, volumes can recover to previous highs as long as the

regulatory framework is not as strict and expensive as it is in the U.S. and Japan.


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