How do binary betting brokers manage risk?

[Pi3141]

Hi,

Does anyone know how binary betting companies like IG, GFT and various other binary option brokers hedge their risk against their clients? I'm guessing that there isn't any real underlying instrument so what do the companies do then?

Also, are these companies allowed to hedge risk by trading with another company? For example, if a client at IG index puts on a big binary bet and IG want to hedge it then could IG place the same bet (if there is one) with GFT?

Thanks,

 

[Hakuna Matata]

Hi,

Does anyone know how binary betting companies like IG, GFT and various other binary option brokers hedge their risk against their clients? I'm guessing that there isn't any real underlying instrument so what do the companies do then?

Also, are these companies allowed to hedge risk by trading with another company? For example, if a client at IG index puts on a big binary bet and IG want to hedge it then could IG place the same bet (if there is one) with GFT?

Thanks,

Probably something like this:

They'll net the delta of their long and short positions to give an an overall delta exposure. When this becomes either too high or low (they are too long or short) they'll hedge it in the underlying and take their delta back to zero.

If their gamma becomes too hairy they can hedge that with one of their counterparties with another option, and then adjust the resulting delta that is added to their position from that.

Just a guess mind.

 

[Pi3141]

Hakuna Matata, thanks for your reply.

Do you think the overall delta exposure is adjusted automatically/instantly via computers and algorithms or is there a person/manager monitoring the overall exposure who then has to make decision as to which underlying to buy/sell?

Also, binary options offer very short term markets (5min, 20min, 1hr) so do you think this hedging occurs during these short time frames too?

Thanks

 

[Hakuna Matata]

Do you think the overall delta exposure is adjusted automatically/instantly via computers and algorithms or is there a person/manager monitoring the overall exposure who then has to make decision as to which underlying to buy/sell?

There's probably a bloke at a desk watching throughout the session, who's job is to keep the delta exposure within some parameters (he might have a bit of descretion to be small long or short). I doubt it's done automatically to keep from excess transactions. Depending on how the floor is organised he might be responsible for hedging whatever the underlying is as well, making prices for big trades for example etc, or alternatively they'll have a guy/desk responsible for the option exposure across several instruments. Each firm will have their own way of doing it.

That being said, they might have emergency procedures in place to autohedge exposures in very fast markets, but I'm guessing.

Also, binary options offer very short term markets (5min, 20min, 1hr) so do you think this hedging occurs during these short time frames too?

Yeah I can't see why not, but I guess the overall exposure over 5mins isn't going to be very big because only small fish are trading them.

I think it might also depend on how much size the firm is doing - someone like IG gets a lot of business done and can afford to put measures like those in place, whereas your dime-a-dozen binary bucket shop probably has a PC/Single Trader/Dog kinda setup.

JMHO though, someone who has actually worked in one will be able to shed more light.

 

[Martinghoul]

That bloke at a desk watching... Name's Kweku, innit?

 

[Hakuna Matata]

That bloke at a desk watching... Name's Kweku, innit?

eh? have I got it waaaaaay wrong?

I think I heard somewhere that Kweku was a "delta 1" trader (I'm certain that's what Jerome was) - is that what these guys are responsible for, ensuring the overall exposure to XYZ doesn't get out of hand?

(Delta 1 traders that is, not the dodgy bet the ranch while no-ones looking guys)

 

[Martinghoul]

Nah, don't think anything wrong... I think, ideally, these guys would probably prefer to run a matched book. They can skew prices (to a sensible extent) to achieve that. But, like you say, if things get too big, they would hedge. How exactly they hedge these, who knows.

And yes, Kweku was doing a bit more than hedging, but still, on a Delta 1 desk, that's what they do. Jerome was purely hedging.

 

[Hakuna Matata]

Nah, don't think anything wrong... I think, ideally, these guys would probably prefer to run a matched book. They can skew prices (to a sensible extent) to achieve that. But, like you say, if things get too big, they would hedge. How exactly they hedge these, who knows.

And yes, Kweku was doing a bit more than hedging, but still, on a Delta 1 desk, that's what they do. Jerome was purely hedging.

Don't you think this is the realm of institutional/professional setups?

I mean, if you skew prices on one side in order to bring in volumes and square your net position up, aren't you relying on the rest of the market to notice? I get the impression that most of the people trading binary options (in the retail marketplace at least) haven't got the foggiest whether they're getting their pants pulled down or it's sale of the century...

** and, one more thing while I've got your ear - just a bit of trivia really. Are SB firms what are referred to as "bookies"? And do institutions trade with them sometimes?

 

[Martinghoul]

Don't you think this is the realm of institutional/professional setups?

I mean, if you skew prices on one side in order to bring in volumes and square your net position up, aren't you relying on the rest of the market to notice? I get the impression that most of the people trading binary options (in the retail marketplace at least) haven't got the foggiest whether they're getting their pants pulled down or it's sale of the century...

** and, one more thing while I've got your ear - just a bit of trivia really. Are SB firms what are referred to as "bookies"? And do institutions trade with them sometimes?

Well, I never assume that people trading anything are stupid. Moreover, it's a mktplace, right? So if you're skewing your price relative to the competition, people are bound to notice, I imagine. At any rate, like I said, I don't have a clue what they actually do; I am only trying to imagine what I would do if I were them.

Well, "bookies" are generally brokers. In the institutional context, these are most commonly interdealer brokers, such as ICAP, ect. And no, I have never seen an institution that would trade with an SB firm. They are two very different worlds, with very different scales, at least for now.

 

[tar]

Nah, don't think anything wrong... I think, ideally, these guys would probably prefer to run a matched book. They can skew prices (to a sensible extent) to achieve that. But, like you say, if things get too big, they would hedge. How exactly they hedge these, who knows.

And yes, Kweku was doing a bit more than hedging, but still, on a Delta 1 desk, that's what they do. Jerome was purely hedging.

You are right , they skew their prices based on clients bias , and they rely on diversification : many markets many time frames , plus the wide spreads ...

 

[tar]

From IG group annual report under Market risk :

"Binary bets are typically difficult or not cost-effective to hedge, and there is often no direct underlying market which can be utilised in setting the price which the Group quotes. The Group normally undertakes no hedging for these markets, but can hedge specific positions if considered necessary. The Group aims to reduce the volatility of revenue from these markets by offering a large number of different betting opportunities, the results of which should, to some extent, offset each other irrespective of the underlying market outcome. The overwhelmingly short-term nature of these bets means that risk on these markets at any point in time is not considered to be significant."

http://www.iggroup.com/content/files/annual_report_12.pdf

 

[Pi3141]

From IG group annual report under Market risk :

"Binary bets are typically difficult or not cost-effective to hedge, and there is often no direct underlying market which can be utilised in setting the price which the Group quotes. The Group normally undertakes no hedging for these markets, but can hedge specific positions if considered necessary. The Group aims to reduce the volatility of revenue from these markets by offering a large number of different betting opportunities, the results of which should, to some extent, offset each other irrespective of the underlying market outcome. The overwhelmingly short-term nature of these bets means that risk on these markets at any point in time is not considered to be significant."

http://www.iggroup.com/content/files/annual_report_12.pdf

Excellent post from Tar! Great idea to look into the company report for info.

Could anyone explain what the sentence in bold means? - I would have thought that since you can place big bets on the short term markets available, the risk would be considered significant rather than insignificant. Or is it simply the case that most clients that trade these short term markets bet between £1-5pp, which from IG's perspective isn't considered a big risk?

Thanks

 

[Hakuna Matata]

Excellent post from Tar! Great idea to look into the company report for info.

Could anyone explain what the sentence in bold means? - I would have thought that since you can place big bets on the short term markets available, the risk would be considered significant rather than insignificant. Or is it simply the case that most clients that trade these short term markets bet between £1-5pp, which from IG's perspective isn't considered a big risk?

Thanks

yeah, something I alluded to earlier.

 

[safvan]

Any poster who thinks that regulated or unregulated binary betting platforms are actively participating in the markets to hedge their risks is a fool.

All the way from top betting shops like IG to your smaller guy like nextdoorbinaries.com, nothing is bought or sold in the back end. If they were so proficient in managing risks, they would not be offering brokerage services but instead investing or trading in the markets themselves.

For them its about profit to loss percentages. If a customer makes a small profit, its okay. As soon as he makes a big one, he gets kicked out. Only the losers are allowed to stay.

Binary betting is all about *new sales*. That is why most of their money goes into advertising.

It works exactly like a casino. All delta, gamma, mama trauma may work in regulated options markets but even then its very risky for a small brokerage. They do not have the logistical capacity to handle risks, while earning pennies to the dollar on commissions.