A Burgeoning Binary Options Market in Israel? Don’t Bet on It

The Israel Securities Authority will soon decide whether to bar this form of high-risk form of investment — at least to Israelis.

Illustration: Binary options.
Haaretz

Israel has become quite the global hub for betting on binary options, via Internet of course. But are binary options investments suitable for everyman, or should they be confined to a game for sophisticated market animals? Good question, which the Israeli watchdog is presently mulling, with a frown on its face.

The attraction is clear. How many of us can be bothered to read corporate financial statements, let alone understand them? How many of us have the patience for long-term saving plans? And who can stand sitting there while our investments rack up a mere few percent a year?

Some of us can. But the capital markets are based on the rest of us, who dream of getting rich overnight, or at least making money without effort.

Companies that offer trade in binary options are banking on people like that. What they offer is, simply, a way to make a killing, fast, by betting on the direction of the market.

How much is a killing? Say about 70% to 80% returns on your investment. How fast? Maybe within minutes.

All you have to do is guess whether the price of a financial asset, or a given stock market index, will rise or fall within a (short) preset period of time, and choose the appropriate binary option.

They’re called “binary” options not because of computers, but because unlike other derivatives sold on the capital markets, there are only two options here: profit or loss.

The rub is that not only the potential gain is tremendous. So is the potential loss. When the binary option you chose doesn’t pan out, you’ll usually lose 80% to 100% of your investment.

Who me, play craps?

If that reminds you of casino gambling, you’re in respectable company. That is the main argument of a lawsuit filed against binary options companies operating in Israel and against their top executives. The lawsuit boils down to arguing that the companies are misrepresenting gambling as investment activity, but are really tapping into the psychological mechanisms of gamblers. The players get to be in denial about gambling and feel they’re engaging in some sort of responsible activity. In other words, presenting the activity as investment in the capital market befuddles the companies’ clients and impairs their judgment.

The companies at the target end of the lawsuit rebut that the options they sell don’t necessarily involve gamble or guess; one can assess the future short-term direction of the capital markets based on knowledge of economics, reading macroeconomic analyses, and understanding the behavior of the markets.

The Israel Securities Authority hasn’t published its opinion of binary options yet, in contrast to the American watchdog, the Securities & Exchange Commission, which has published warnings to investors. So have market watchdogs in some other countries. Officially, as markets regulator, the ISA is still mulling whether binary options are a legitimate form of investment by ordinary folk. But recent remarks on the topic by ISA officials have been escalating, and the writing seems to be on the wall.

Israel is quite the superpower in binary options trading – but most of the companies’ activity is directed at foreign investors. But if the ISA has its way, it seems a lot of Israelis are going to get barred from the game.

‘A guessing game’

The chips hit the fan in October 2015, when the ISA sent a letter to the binary options companies, elaborating its reservations about their activity and stating intentions to constrain it, and to limit their potential clientele to sophisticated investors with deep pockets.

Presently, trading in binary options is open to anyone. One doesn’t need to prove any competence in trading or to have particularly impressive amounts of money.

Sources involved in the industry say the ISA’s letter portends the end of the binary options industry – and it was just the tip of the regulatory iceberg.

The ISA’s position on binary options and the man in the street became a lot clearer in its opinion delivered to the court in that case against the companies. According to its position paper, the ISA is deeply worried about what goes on in that industry.

Examination of the financial assets classified as binary options shows their sheer complexity makes it significantly difficult for investors to price them efficiently, and make informed decisions about their merit, the ISA wrote, and added, “In binary options, in which the client loses a higher pre-set amount if they expire outside the money, versus the fixed amount he would make if they expire in the money, the client is placed in a structurally inferior position. The short time to expiry exacerbates the problems. Also, the expiry ranges are too short a time for informed economic analysis by the client of the investment’s merits.”

“The difficulty in pricing binary options becomes worse because they are not liquid, and there isn’t enough information from similar instruments,” says Itzik Shurki, director of the Stock Exchange and Trading Platforms Supervision Department at the ISA. There are also the short ranges to expiry, which can be just a few seconds or minutes, he adds, and the asymmetry between the potential profit (smaller) and loss (bigger). “All these features give trading in options the character of a guessing game. Therefore, the ISA staff intends to recommend that the [binary options] arenas be barred from offering trading to the general public.”

Sources near the ISA think it may wrap up regulation of the binary options arenas by October this year. The ISA has even published a tender for software to monitor and supervise the arenas in real time.

The companies profess astonishment at media reports on the ISA’s position. “We cannot believe that after years of discussion and gargantuan expenses, both by the state and by the companies adapting their activity to the requirements of the law, that the ISA would reach a different decision from its American, European, Japanese or Australian counterparts, and restrict activity in binary options to suitable clients,” says Shay Datika, co-founder of eTrader.

Resorting to the G-word

The ISA is careful not to use the word “gambling” in respect to binary options trading. Gambling is illegal in Israel, with two specific exceptions: the Mifal Hapayis national lottery, and the Toto sports betting organization.

Therefore, whether or not trading in binary options is “gambling” is a loaded issue, and is central to the lawsuit against the three companies – eTrader, Manx Online and Twenty Four Group, who are being sued by former clients.

The plaintiffs argue that the companies exploited their inexperience and sold bets in the guise of legitimate capital market activity. They came to court equipped with a legal opinion, that the manner in which trading is carried out in these arenas does not enable the customers to conduct economic analysis of the investment.

The claims listed in the opinion are very similar to the reservations the ISA lists in its position paper submitted to court.

The companies for their part rebut that since their industry is supervised and regulated by the ISA, the clients can’t argue that the companies are guilty of criminal behavior. They also came armed with a legal opinion that contradicts that of the plaintiffs.

Interestingly, eTrader itself (the biggest of the three) recently uploaded a text to its website, titled “Regulation of Binary Options”. In the text, the company states, “After years in which the industry was unsupervised, recently new regulations from the Israel Securities Authority came into force to regulate trading on electronic platforms, including forex and binary options. The regulation is good news for many Israelis who had been burned in the past from this industry, and for many others who forwent taking part in it because of the risk and the absence of supervision.”

Operating in the dark

It isn’t clear whether this statement is any use to the clients suing the three companies. But it is clear that the ISA is frowning on the industry and plans to profoundly change it.

The watchdog hasn’t spoken out on another key activity of these platforms, which is the forex activity — betting on the direction of currency exchange rates. But even if the forex companies take less of a hit than the binary options industry, being regulated will change it a lot. In that, the eTrade people are apparently right.

Meanwhile, note that not one single company has been licensed to operate in electronic trading of forex and binary options. None. Twenty-one have applied and have been allowed to operate while the ISA discusses the applications. What happens if the ISA decides to reject any or all? It can shut them down on the spot, that’s what.

It is worth noting that a company has to at least apply for licensing before it can operate in binary options. If it doesn’t apply, but starts offering the goodies, the ISA can take steps against it.

Yet observers say that while the ISA is a very strong institution with broad powers, it is limited in its ability to move against errant companies. For instance, the Knesset reined in the powers the ISA sought to receive real-time information on the companies’ activity while their licensing applications are being discussed.

The bottom line is that we cannot know, at this point, if the ISA is going to crush and kill off the binary options industry in Israel. But note ye this. It can only act against electronic trading platforms if they work with Israeli clients. If they work exclusively with foreign clients, the ISA can do nothing. So one very possible upshot is that the sites will stop cooing at Israelis – but the companies will continue to operate from Israel and offer their wares to the rest of the world. Which is what most of them already do anyway.