A binary option is a type of option where the payoff is either a fixed amount of some asset or nothing at all. An example of binary options is “cash or nothing” binary options. These are binary in nature because there are only two possible outcomes:
- The option will pay some fixed amount of cash if it expires in the money or,
- The option pays nothing and has null value if it expires out of the money.
The Regulation of Binary Options in Malta
Maltese companies selling binary options need to be licensed. Prior to the July 2013, binary options were regarded as being a gaming product and were thus regulated by Malta’s Lottery and Gaming Authority. Nowadays, a person who is interested in carrying out any investment service in relation to binary options in Malta must hold a license in terms of the Investment Services Act issued by MFSA. Like other investment services, this means that such products can be offered to consumers in other EU Member States by passporting the licence following MFSA notification.
Different categories of licences
Generally, in the case of online selling of binary options, one of two categories would be applicable: either by dealing on own account or by acting as a riskless principal. Different licences apply for the two categories.
Category 2 license – If a binary options trading company is acting as a riskless principal (‘white label partner’), a category 2 license applies. Under this category, the company is authorised to provide any investment service, and to hold or control clients’ money or customers’ assets, but not to operate a Multilateral Trading Facility or deal for their own account or underwrite or place instruments on a firm commitment basis.
In such case, the entity is involved in a back-to-back transaction entered nearly simultaneously and at the same price, with the entity acting as counterparty to both transactions (margin making). The entity is involved solely in executing two matching trades and is not itself creating prices. Exposure is significantly less than those of traders dealing on own account (which would require a Category 3 licence). The requirement to obtain a category 2 license is that a minimum capital of €125,000 is required. Furthermore, the company must have its own funds which are higher than either (i) the initial capital, or (ii) the sum of all the risk components calculated in terms of the rules but excluding the operational risk component or (iii) the fixed overheads required. An MFSA Category 2 license application requires payment of an application fee of €5,000.
Category 3 license – if the trader is dealing on his own account and is therefore a market maker. the trader would require a Category 3 investment services licence. A category 3 licensee needs an initial capital of €730,000. A company applying for this license should have its own funds which are higher than either (i) the initial capital; or (ii) the sum of all the risk components calculated in terms of the rules including the operational risk component. An MFSA Category 3 license application requires payment of an application fee of €7,000.