In the last post I talked about how to develop your forex binary options trading system. In this post I am going to go deep into the topic of how binary options brokers make money. This is something very important for you to know before you embark on your journey of trading binary options. Binary options brokers are very different from forex brokers.
Forex brokers are mostly market makers. Firstly forex brokers charge a commission in the form of bid-ask spread when you open and close a trade. This spread can be 1 pip for liquid pairs like EURUSD, GBPUSD etc but it can be 20-50 pips for exotic pairs like USDTRY, USDMXN etc. Secondly if you click buy, the broker will take the opposite sell position. In the same manner if you click sell, the broker will take opposite buy position. So in essence the forex broker is trading against you. But the situation has improved with the coming of ECN brokers on the scene.
Binary options brokers are different. Binary options brokers don’t charge any commission on trading. Then how do you make money? Simple. When the trader loses money, the broker makes money. When you buy a call option, the broker gives you the guarantee to pay you a return something like 75% for most brokers if you win the trade. If you don’t win, you lose your investment. Let’s take a hypothetical example.
Suppose there are 1000 registered traders with a binary options broker. 500 of these traders bet $100 that GBPUSD price will end up higher 30 minutes later. The other 500 traders bet $100 that GBPUSD price will close lower 30 minutes later. The broker pledges first 500 trader 75% return if they win the call option. The broker also pledges the other 500 traders 75% return if they win the put option.
Since each trader invests $100. The total money invested with the broker is $100K. Now either the price will go up or down. Only one group can win. Suppose GBPUSD closes higher 30 minutes later. 500 traders win. Broker pays them 75% return. Since the investment is $100, the broker will pay them $175 and the total payment to 500 traders will be $87,500. Broker has $100,000. So the net profit for the broker will be $12500.
This is in nutshell how the binary brokers make money. This is primary reason why the return offered by the binary broker is always less than 100%. 100% return means the broker will have to pay $100,000 to the 500 traders who won the call options. How much the broker keep? Nothing. So in order to make a profit the broker always offer a return less than 100%. This was a hypothetical example simplified so that you can understand how the binary brokers make money. Watch this video also that explains how the brokers make money.