You may have wondered how binary options brokers make money, since they don’t charge you a commission to trade. While there are several ways that binary options can make money, one of the main ways is in the payouts percentages that you see every day on their sites.
A Near Riskless Profit
Binary options brokers are able to make a near riskless profit by offering certain percentage payouts, and through active trading by clients. With a large number of clients we typically find that roughly 50% of traders believe an asset will rise and the other 50% believe it will fall. This may get skewed one way or another during a strong trend, with more traders believing an asset will rise or fall, but we find that the usually the number of put and call buyers fluctuates between about 40% and 60% and vice versa. Over the long-term this should average out to about 50/50 buying calls and puts. This shown by sentiment indicators such as Cedar Finance’s “Trader’s Choice:”
Figure 1. EUR/USD Binary Option
So with such an active market and traders taking both sides of the trade, the binary options broker is able to pocket a percentage of the action. To keep things simple assume a binary options broker has 100 clients: Roughly 50 buy calls and roughly 50 buy puts. When the option expires the winning 50 traders will receive an 80% payout in addition to their investment back. The losing 50 traders lose their investment. Now assume each trader placed $100 on the trade. 50x$100=$5000 which is how much the binary option broker receives from those on the wrong side of the trade. They then pay out winners: 50x$80=$4000. The broker received $5000 but only had to pay out $4000, reaping a $1000 profit.
It’s Slightly More Complex Though
The above example is a simplified perfect example. In the real-world not all traders are going to bet the same amount, and it is unlikely to be perfectly divided (50/50) between call buyers and put buyers. This is why binary options brokers want lots of trading activity in lots of assets. The more traders they have, and the more options that are traded in multiple asset classes the closer they get to achieving the ideal scenario described above. With multiple assets offered and all being actively traded, if the broker ends up needing to pay out a little more to winners than it receives from losers (say the winners greatly outnumber the losers, or much more money was placed on the winning side than the losing side) on a particular option it doesn’t matter, because they are likely to make money on most of the other options they provide. In other words, over a huge number of trades the binary options broker has a statistical advantage. Over the long-run they will likely pocket the percentage difference between the losing take (usually near 100%) and winning payout (typically 60% to 80%).
Do Binary Brokers Trade Against Their Clients?
Some may think that binary option brokers are trading against their clients, since all trades are simply placed with the broker and not on the exchange of the underlying asset (such as the stock, forex or futures market), but this isn’t necessarily true. As described above the binary options brokers are actually better off when they are simply a middle man, allowing call and put buyers–traders with differing opinions–to come together. The payout structure allows binary options brokers to make money assuming a diverse group of clients, without taking opposing positions to clients. Also, taking positions opposite clients could put the firm at risk if they are on the losing side of a large trade, or use unscrupulous tactics to swing a trade in their favor when it shouldn’t be. Neither of these are good business practices given the binary options broker model, and therefore reputable brokers will rely more on the difference in payouts than taking the opposite side of a clients order. It is also worth pointing out that since clients are on both sides of the market–buying calls and puts–there is little need for brokers to engage in a conflict of interest such as trading against one group clients (either call buyers or put buyers, because they can’t trade against both).
Other Profitable Endeavours
There are a couple other ways binary options brokers may make money:
- Miscellaneous fees, which will vary by broker, such as withdrawal fees or managed account fees.
- Interest received on deposits. You give the broker money to fund your account, and while you may not receive in interest on your deposit, the broker may be making interest client deposits.
Typically binary options brokers make money by pocketing the difference between the percentage losers lose and the percentage winners make. They also may make money off of fees for services or interest collected on deposits. While it is possible that binary options brokers may take the opposite side of a client’s order, this is generally not the norm. Brokers are far better off being a middle man and simply bringing call and put buyers together and collecting the near riskless profit provided by the payout differential.