Is trading binary options equivalent to gambling? Well, binary options are considered to be very speculative and thus dubbed as “gambling” at times.

With the recent warnings from the MAS, investors and traders alike should be well-educated with the basics of binary options, at least, before thinking of trading them – regulated or unregulated.

What is binary options trading?

thinkingman

We might have heard it somewhere before that it’s quite similar to “big-small” (大小) gambling in that there are only two options to “bet” on. That is true to a certain extent.

It is called “binary options” because, technically, there are only two optionscall or put, hence the name, “binary options”.

What are “calls” and “puts”?

Unlike “big-small”, which is entirely based on luck, binary options trading is based on the trader’s guess whether the underlying asset will be higher or lower than its current price at a specific time in the future.

A trader will enter a “call” position if he or she thinks that the underlying asset will rise in price while a “put” position is when the trader believes the price will fall.

With that in mind, it’s not exactly gambling in some ways because the trader can still make an educated guess based on probability. Then again, no one can accurately predict anything in the stock market regardless of how much information he or she has – it merely lowers the risk.

How risky is trading binary options?

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A trader will win or lose a fixed amount of money from trading binary options. The trader will be informed of the potential win and loss amount beforehand, too.

Therefore, in terms of how both “big-small” and binary options work, they are both equally risky – if the “player” and trader predicts wrongly, they lose their entire investment.

Wins from “big-small” bets vary in terms of prize money but for binary options, the trader will be given a fixed amount of winnings if his “call” or “put” is correct.

Riskier than traditional trading/investing?

However, herein lies the heavy risk in binary options trading as compared to traditional trades or investments. Binary options trading requires the trader to buy “call” or “put” contracts, which essentially locks up the trader’s money.

This also means the trader wouldn’t be able to set a stop-loss or any other risk-managing strategies the moment he or she purchases the “call” or “put” contracts in binary options trading. The risk management is only possible before the trade.

Binary options brokers will tell retail investors that binary options trading is simple and easy. But they sometimes don’t tell them the risk involved. It is equally easy to win and lose money when trading binary options.

Example of a binary options trade

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To paint a clearer picture, imagine Trader A thinks that the Straits Times Index (STI) will go above 3,200 points by the end of the day, up from its current position at 3,170 points and wishes to buy a “call” option contract on the STI.

Trader A gives the binary options broker a phone call (no pun intended) and the broker tells him that each “call” option contract costs $20 and the fixed-return is $30. The potential profit Trader A can get is $30 – $20 = $10 (50-percent profit, minus broker fees if applicable).

Trader A purchases five $20 “call” option contracts for a total of $100 and waits. If by the end of the day, the STI closes above 3,200 points, Trader A will receive $30 X 5 contracts = $150 and his profit is $150 – $100 = $50.

On the other hand, if the STI doesn’t close above 3,200 points, Trader A loses his entire $100 trade. His potential profit is 50 percent while his potential loss is 100 percent of his trade. Is it still that attractive?

If the STI happens to close at exactly 3,200 points, Trader A might get back his $100, without profit or loss. But it might differ across brokers.

Conclusion

This article is not to discourage anyone from trading binary options. But every retail investor should do their due homework when trading any financial instrument.

Also, we should try to stay away from unregulated brokers, as advised by the MAS. The law can only protect us from fraud if we stay within legal boundaries where we’re covered. We wouldn’t want to be like this man.