Beware the scam merchants in binary-options trading

On 29 March last year the UK’s financial watchdog, the Financial Conduct Authority (FCA), banned the sale, marketing and distribution of binary options to all retail customers. It’s a step in the right direction. But unfortunately the binary-options bubble continues to brew. Unless more decisive action is taken, more and more people are going to be cleaned out of their savings by unscrupulous operators. 

A binary option is similar to a normal (“vanilla”) option, where you pay a premium for the option to buy or sell an instrument at a fixed price (the exercise price – see box below for a detailed explanation). Profits or losses on vanilla options can be small or large, depending on the difference between the “exercise” price and the price of the underlying asset. 

Unlike normal options, however, binary options do not fluctuate in value. Either the option is “in the money” on expiry – in which case it pays out – or it isn’t, in which case it expires worthless. Because of this binary nature, many shysters see an opportunity in selling binary options that are highly unlikely to end up in the money. They get to collect the hefty premiums, but never have to pay out.

Don’t be suckered by wild success stories

The media is part of the problem. Journalists, particularly those working at online content mills, are so desperate for content that might “go viral” and garner lots of hits that they’re quite willing to run a story with a click-bait headline without doing much (if any) background research. Take the recent tale of a 16-year-old “self-taught currency trader”, who apparently turned £150 into £60,000 in less than a year. This dubious success story was widely shared on social media without many questions being asked. Yet if we take those returns and calculate them on an annual basis, this 16-year-old’s return for the year would be 39,900%. That would literally make him the best trader of all time. So how did a 16-year-old school kid learn how to outsmart the best minds and machines on the planet, just by watching YouTube videos? As nobody asked him, sadly we’ll never know. 

There was also the very recent example of Gurvin Singh, a 20-year-old medical student in Plymouth who claimed to be making six figures a month from foreign exchange trading. One major newspaper reported this month that more than 1,000 investors were sucked in by Singh’s Instagram account, which showed him posing in designer clothes with expensive cars at plush holiday resorts. Those who signed up for his services found that their trading accounts were emptied on Christmas Eve and the FCA has added him to its warning list of unauthorised traders (after the fact, unfortunately). But what the paper doesn’t mention in this particular piece is that Singh’s “success” was first reported on its own website in breathless, no-questions-asked fashion, in November, just a month before it all went horribly wrong.

This aggravates me because, as a genuine trader, I work hard to make profits and I know what it takes. I also don’t like to see people being conned. So I want to unpack this story for you, so that you don’t end up falling for one of these scams or something similar.  

How does the binary-options scam work?

There is a reason why so many gentlemen (it’s usually men) in their early 20s now apparently own private jets, luxury cars and slick watches. It just may not be because they’ve cracked the financial markets as they claim. As Charlie Munger, Warren Buffett’s business partner, puts it: “Show me the incentive and I will show you the outcome”. There are many reputable financial-trading firms and brokerages out there. However, many – ones that I would describe as “bucket shops” – are not so reputable. Spread-betting firms typically make their money on the spread (the gap between the buying price and the selling price) and the commission paid by their clients. So their business model does not benefit from losing traders. 

However, many brokers know that a losing trader can be very profitable – for them. If you know that 90% of traders will lose all of their money within six months, what do you do? Simply take the other side of the trade. When Johnny Punter buys, the broker sells. And when Johnny Punter wishes to cover his losses, the broker buys and collects the profit.

Unprofitable traders are so profitable for many a bucket shop that they will pay handsome introduction fees for new traders. Therein lies the incentive. It doesn’t matter if you’re actually making any money from your trading – if you can get even a £20 incentive for every trader who signs up with the minimum deposit of a few hundred pounds, then you only need to sign up 1,000 people a month to make £20,000. And the reality is that these brokers aren’t offering just £20 for new clients – they’re offering hundreds. I know they do, because I’ve been offered it.

The Pied Pipers of foreign exchange

If you’re not a successful trader, the next best thing is to fake it. A quick Google search reveals that you can rent a Lamborghini Huracan for four days at a price of £2,500. This is fairly steep – but you can rent a Lamborghini Gallardo for two days for £1,590. Two days is more than enough for a wannabe forex guru to take hundreds of snaps in different outfits, parking in fancy residential estates that they don’t live in and overall giving the impression over several months that they really do own a six-figure supercar. And of course, there are plenty of places to hunt down a cheap, out-of-season stay at a luxurious five-star hotel, where they can do exactly the same. Then they just pop it all on social media and wait for eager punters to line up to sign up with their “exclusive broker”. 

Many brokers offer demo accounts, in which case the “guru” can just repeatedly put on ten trades in a row, come out with winners, then screenshot it and post it on Instagram. If even that is too difficult a task, then it’s a simple matter to fake the picture instead using image manipulation software and post that. With “evidence” of their success sorted out, the trader then promotes their wares with promises of “signals” that have 90% success rates, alongside key phrases such as “no risk” and “guaranteed profit”. Most informed investors realise that if a magic money-making machine did exist it would be owned by a private hedge fund, never to see the light of day. So anyone who actually believes that a 20-year-old student could pull this off is ideal bait – inexperienced, naive and potentially desperate. 

The scam also succeeds because of how victims feel when they finally realise they’ve been suckered. Most don’t tell anyone because they feel foolish and want to save face. But also, they know (or rapidly learn) that there is very little the police can do. The banning of the sale of binary options was a step in the right direction. But now the traders of Instagram simply give away their “signals” to trade these options for free. And many bucket-shop brokers are overseas – often they’re not even doing anything illegal in the country in which they operate (although equally often the traders in question will imply that the bucket shop is a reputable UK-based and regulated institution, or lie flat out). 

There are even operators who will manipulate the punter’s account in order to make them believe they are winning and then call on them to deposit more money. Then, when the client finally wishes to withdraw, the company goes cold and refers them to the small print, in which it says that the client must trade through an impossible amount of money just to be allowed to withdraw. Other brokers allow the affiliate to widen the spread to maximise their own commission and increase losses for their clients. We look at ways to avoid being scammed in the box below, but in short, as always – if it looks too good to be true, it is. 

For more from Michael, see shiftingshares.com.

How to avoid being scammed

Stick with the UK: ensure any broker you use is UK regulated. And stick to well-known names – online reviews can be faked.

Avoid “signals”: magic money-making machines do not exist. Watch for fakes: many of these firms have a name that sounds vaguely like a City institution. Check out fca.org.uk/scamsmart for warnings and check with Companies House to see if a company exists. But even if it passes both tests, don’t assume it’s legitimate.

Hang up on cold callers: assume that all cold calls are scams.

What’s in it for them? Very often people don’t disclose huge conflicts of interest.

Traders aren’t fashion models: Beware people who post more pictures of their lifestyle than of their actual trading.

What is an option?

A put option gives the holder the right (but not the obligation) to sell an asset – that is, a share – for an agreed price on or before a given date. When you buy a put option, you pay a fee (premium) to the seller (“writer”) of the option. You can use put options to bet on the price of an asset falling. Your potential loss is limited to the premium paid.

Say Acme Widgets is trading at 100p a share and a put option to sell at 90p costs 5p. You buy a block of 1,000 options at a cost of £50 (5p x 1,000). If the shares fall to 70p, you would make a profit of £150 ((90p – 70p – 5p) x 1,000). However, if the shares go up – to 120p, say – you would just let the option expire. In that case, you lose your premium of £50 but nothing more. A “call” option is similar, but gives the right to buy an asset at an agreed price. 

The price of an option is determined by a number of factors, including the volatility of the price of the underlying asset (options on more volatile assets will be pricier). So option prices tend to rise during market turmoil. The length of time before an option expires is also important – options that expire further out into the future are more expensive.