By Gary Smith
Over-The-Counter and Exchange Traded Binary Options: What’s The Difference?
Did you know that binary options can be traded on certain exchanges? Here, we put both over-the-counter (OTC) and exchange traded binary options under the spotlight to help you decide which way into the binary options marketplace might best suit your needs…
From Forex through to individual stock prices and, recently, even which way the Brexit vote will go (with IG) , binary options offer traders the opportunity to put their skills to work and take a position across a vast range of areas. But whatever it is that you’re trading, all binary options share one key feature: at expiration of the option, there are only two potential outcomes: all or nothing.
Whether you hold a binary option contract that was issued directly to you (i.e. an OTC binary option) – or if you’ve purchased an option that was originally issued to another party (which is essentially what the exchange traded binary options market involves), this “all or nothing” principle remains the same. In other words, if you are “in the money” when the option expires, you receive the fixed amount stipulated by the option.
What’s more, both OTC and exchange traded binary options are readily accessible to individual traders via easy-to-use online platforms.
So from a practical point of view, it might seem that there is little difference between OTC and exchange traded binary options. In fact, there are several key differences – not least when it comes to how the marketplace is set up. To explain, here’s a summary of the main features of each model…
OTC binary options
For individual traders, OTC binary options first arrived on the scene in around 2008, when online platforms first started issuing their own options. A quick glance across these platforms demonstrates that these operators offer binary options for almost any tradable financial product; traders can go long or short and the potential return is stated before the trade is opened.
The draw of this type of product – especially for non-professional investors – is the opportunity to take a position on the markets in an accessible and relatively straightforward way. The fixed payout and fixed timeframe is a big part of this. Where these two features are absent from a spot market instrument, it throws up lots of additional concerns for traders to juggle, such as how to set an exit point and when to recognise and stop a losing streak. With a binary option by contrast, the focus is narrowed to three main concerns: the trends to take a position on, the value of the initial stake and the entry point. The dilemma of knowing when or whether to get out or retain your investment is removed from the equation.
Top 3 OTC Brokers:
Exchange traded binary options
Especially in their early days, OTC binary options came under scrutiny in some quarters, not least because regulatory bodies appeared uncertain on whether to treat them as a product to be regulated as a form of gaming or as a financial product. Criticism has also centred around how OTC platforms make money- i.e. not through charging fees or commissions, but rather, as the counter-party to the customer’s positions: in short, the customer is always betting against the house.
Exchange traded binary options offer an alternative way forward. In 2007, the Options Clearing Corporation changed its rules to allow binary options to be traded, which means it is now possible for these options to be traded on several regulated exchanges, including Daweda in the UK, and the CBOE and NADEX in the US.
With exchange traded binary options, it remains the case that each binary option contract has a fixed payout, but the price of that contract changes depending on what other traders are willing to pay for it. Unlike the OTC market where the platform is the counter-party, with exchange traded options, the exchange is essentially the middleman, matching buyer with seller. For this, a commission is charged.
Choosing between the two: points to bear in mind…
- OTC binary options offer the simplest way into the market. It’s possible to quickly view what trades are available and instantly take a position. On the other hand, the more complicated pricing model for exchange traded options raises the possibility of being able to use option pricing models and strategies to take a view on whether a particular option is under or overpriced. For a more seasoned trader therefore, the exchange traded model adds that extra level of analysis and further opportunities to generate profits.
- Betting against the house is not an issue when trading via exchanges. The pricing is therefore not skewed against you and instead is determined by the markets.
- Exchanges are more tightly regulated than OTC platforms and are required to follow strict rules regarding service standards and handling of your money. Bear in mind, however, that it’s possible to remove the risk of a bad OTC experience by sticking with a reputable platform. To source the best and to choose the one you are most comfortable with, head over to our broker comparison and review.