Friday, June 7, 2013

SEC Warns Investors About Binary Options

By Tim Dulaney, PhD and Tim Husson, PhD

The SEC has issued an Investor Alert (PDF) on binary options, which are derivatives that pay out a fixed amount if an event happens and zero if it does not.  We've covered binary options before, so do check out that post for a detailed background and an Excel spreadsheet that explains how binary options work in some detail.

The Alert highlights several risks of binary options, mostly relating to how they are traded.  It notes:
Much of the binary options market operates through Internet-based trading platforms that are not necessarily complying with applicable U.S. regulatory requirements and may be engaging in illegal activity.
The Alert was issued simultaneously with charges against a Cyprus-based firm who allegedly sold them illegally to US investors through just such an online exchange.  That firm, Banc de Binary, was charged with selling binary options since 2010 "without first registering the securities as required under the federal securities laws."  The CFTC is also investigating Banc de Binary for related violations of its rules relating to off-exchange trading of commodity options contracts.

Binary options can be used to effectively gamble on any type of event, including non-financial events.  A wide variety of online brokerages and exchanges have been created for just this purpose, but it appears the SEC and CFTC are cracking down on these more obscure exchanges.1
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1 Perhaps the most well-known example is InTrade (recently shut down).

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