Can You Make Money from Binary Options: The Odds Examined

Binary Options have become a very popular instrument online with numerous Binary Options platforms popping up everywhere. Many new traders are attracted to the high potential returns that these simple financial instruments offer, however many critical of Binary Options have noted that the odds appear to heavily stacked in favor of the provider. Today we are going to examine, whether the odds are unfairly stacked in favor of the Options providers.

When entering into a Binary Options contract you can either place put or call, this gives you two options. If one was to assume that the market was equally as likely to go either way the fair rate of return would be 100%. This situation would give neither party a distinct advantage and the party that came out the winner in the long run would simply be lucky. The trading of Binary Options differs from this hypothetical situation in two crucial respects:

  1. Binary Option providers typically give returns substantially lower than 100%. 
  2. Markets tend to trend in a particular direction meaning that market isn’t equally likely to go either way.

Taking these two crucial differences into respect it becomes a lot more difficult to determine whether Binary Options as typically priced give a trader a fair shot at victory in the long run. Typically short term Binary Options offer a rate of return of around 70%, which means in order to have neutral expected value a trader would have to predict the market accurately around 58-60% of the time. This means that a trader would have to predict price movement with 58-60% accuracy just in order not to lose any money. If either outcome was just as likely it is clear that the trader would be getting a raw deal and we could expect him to eventually lose all his cash to Binary Options brokerage.

MonteCarlo Simulation

It does however appear that Binary Options could be profitable for those who could predict the market with a 60% degree of accuracy. It should be pointed out that not many trading systems can make sure term price predictions with that kind of degree of accuracy, many traditional trading systems are much less reliable but overcome their unreliability through proper risk management. For instance many Forex systems can be profitable while only correctly predicting market action 30% of the time. As a fixed-return option contract Binary Options don’t allow for this kind of risk management. If you were only able to predict price movement to a 30% degree of accuracy, you would be a significant loser trading Binary Options. In the MonteCarlo simulation I ran above it took 22 trades to bust the trader.

PredictionOverall OutcomeProbablity
Correct700.642
Incorrect-1000.4-40
Expected Value2

Binary Options do appear to have the potential to be profitable for those who are able to predict the markets with a very high degree of accuracy. Anyone who can reliably predict market price action with a degree of accuracy in excess of 60%, can expect to make a profit from trading Binary Options. However the number of people/systems which will be able to accurately determine price movement with such a degree of accuracy is likely to be extremely limited. I also believe that statistical variance could potentially lead to many people believing they have determined a highly accurate way to call the markets, before realizing that they have in fact just had a prolonged lucky run.

As Binary Options brokerages operate as a counter party to a trader and there is no way to hedge positions, it is unsurprising that the product is setup in such a way which makes it unlikely for individual traders to beat the provider in the long run. While I wouldn’t go as far as to deny that some individuals will be able to make money trading binary options, I would strongly advise that individuals take a serious look at whether they can really predict market price action with such a high degree of accuracy. If so, then you may just have a real shot at making money from Binary Options trading.

This Post Has 2 Comments

  1. james says:

    Binary options are alright, but I wouldn’t say it’s the best way to make money in 2013. The biggest problem I see is that it’s too risky (not many reputable brokers). I would only trust official US licensed ones. The only ones I know of are “How We Trade” and “Nadex”. Don’t trust ones located in placed like Cyprus or Malta. Those are the true scams.

    • Ed says:

      I would agree that exchange traded Binary Options are alright, as you can apply traditional option pricing to them etc. The off-exchange Binary options (which shouldn’t be offered to US citizens due to CTFC and SEC regulation) which are offered by many of the firms based in Malta and Cyprus, are no more than fixed odds gambling. But I wouldn’t go onto say they were scams, more that they are just a bad product (though there have been firms which have engaged in dubious practices).

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