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06 September 2016

Dickens, Schrödinger and Binary Options



A couple of weeks ago I came across the following imagined conversation on Twitter, which really made me smile:

“Dickens: It was the best of times, it was the worst of times.

Schrödinger: Nice, nice.”

Now, skipping lightly over the fact that Schrödinger in fact described his cat thought experiment as a ridiculous proposition (which is not necessarily how quantum physicists would see it), I thought it was a nice illustration of things existing in dual states - French Revolution good and bad, in A Tale of Two Cities, and cat dead and alive in its steel container.

One of the current vogue games for certain parts of the investment field is the trading of binary options. Dickens and Schrödinger were talking about things existing simultaneously in two states; one could argue that binary options do that, in a way, and that the expiry moment is rather like the opening of the cat’s container when you find out if it is dead or alive. On expiry, you find out if you have won or lost. So, a binary option is a bet - whoops, better call it an investment, according to the sellers’ websites - that a particular commodity, currency, index or whatever, will be either above or below a certain fixed level at the end of a fixed period of time and it offers a fixed payout or zero, which distinguishes it from a conventional option. The time period is normally short - five minutes is typical, and I’ve just been watching the FTSE binaries quoted on one of the spread-betting websites flicking around over a five minute span; no question, it is mesmerising, as you try and guess which way the next move is going to be. To be honest, watching horses go round a track is more fun, but I suppose you can’t do that at home (it’s never the same on TV).

Guess is the right word, though, because, delving a bit more into some of the broker websites that offer this stuff, I came upon some advice for strategies to use in investing in binary options. So, the punter is told:

“While technical analysis can be pretty complicated, there are much simpler ways of interpreting charts, especially when it comes to binary trading.”

“Binary option trading requires very little experience.”

“Fundamental analysis… (then there follows a brief, a very brief, description of fundamental analysis) …keep in mind that using a good binary trading robot can help you skip these steps completely.” 

Well, it’s good to know that bothering to learn is pointless and that you can skip around knowledge with a carefree wave. The disturbing thing is that it’s probably true, but in a bad way not the good way projected by the websites.

A statistical analysis of the the pricing of these products has concluded that the ‘edge’ the house has in making the price means that in order to break even on a series of these deals, an - I’ll use the word for the moment - investor would have to be right 54.5% of the time. Now, we all know that the probability of a tossed coin landing on one side is 50%; the probability of the asset price in question moving up or down in the time period is similar, with the rider that - unlike a coin - it could finish neutral, in which case a partial refund of the original payment is generally returned. The statisticians who conducted the survey have taken that into account in coming to that 54.5% figure. So think about that for a moment; betting on a 50:50 outcome, and accepting a 45.5:54.5  win probability. It doesn’t really make sense, and it is a good indicator of why the press stories about the brokers offering these products features their high earnings, Bentleys and Ferraris. 

Banning things in a free society is rarely the way to go, and frankly those who get involved with these products are only harming themselves. After all, who are we to determine how anybody should spend their money, even if choosing something that specifically tells you that you don’t need any knowledge or experience, yet is marketed as ‘investment’ seems pretty stupid? A fool and his money, and all that. 

But the regulatory authorities need to take a look at this, because marketing what is a straightforward gambling product as a financial derivative seems inherently wrong. Of course, at the ‘respectable’ end of the business, we refer to them as digital options, and in fact I have on a few odd occasions been asked to quote them. However, I’ve yet to find a buyer who can explain them as part of a coherent hedging policy. Wouldn’t it be better to accept that they belong in the gambling industry, regulate them as such and get rid of the fiction that they are investments? That way, the sellers wouldn’t have to tell you that you don’t need any knowledge to have a punt. 

You’d still be better off finding somebody to toss a coin with, though; at least that way you’d have the one in two chance of a win that would be statistically correct.


 


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