Bloomberg Opinion: Money Stuff by Matt Levine: ‘Actually it is a 2 billion dollar Deli’ (21st April 2021)
On Friday, though, the SEC brought a case against another Israeli binary-options company, called Spot Option Ltd., that is a little different. Spot Option, according to the SEC’s complaint, is not in the business of selling binary options to retail customers. It’s allegedly in the business of selling binary-options businesses to binary-options scammers (including Banc de Binary, Bloombex, LBinary, etc.).
From the press release:
The SEC alleges that the defendants developed nearly all of the products and services necessary to offer and sell binary options through the internet, including a proprietary trading platform, and that they licensed these products and services to entities they called “white label partners,” who directly marketed the binary options. According to the complaint, Spot Option instructed its white label partners to aggressively market the binary options as a highly profitable investments for retail investors. As alleged, investors were not told that the defendants’ white label partners were the counter-parties on all investor trades, and thus profited when the investors lost money. To ensure sufficient investor losses and make the scheme profitable, Spot Option allegedly, among other tactics, instructed its partners to permit investors to withdraw only a portion of the monies the investors deposited, devised a manipulative payout structure for binary options trades, and designed its trading platform to increase the probability that investors’ trades would expire worthless. According to the complaint, the defendants’ deceptive business practices caused U.S. and foreign investors to lose a substantial portion of the money they deposited to their trading accounts. The defendants allegedly made millions of dollars as a result.
In the SEC’s telling, the binary-options business is so good and easy and lucrative that it comes in kit form: If you want to sell binary options to suckers, Spot Option will tell you how to do it, write scripts to pitch it, and give you the software to run it.
From the complaint:
Spot Option developed and provided its Partners with a turnkey package of products, software, and services that included nearly all of the tools necessary to offer and sell Spot Option’s security-based and other binary options online to anyone.
Spot Option advertised to potential Partners that its package “generates great revenues with minimal efforts” and that it would enable Partners, under their own brand names, to operate an online business selling binary options in as little as four to six weeks. Spot Option described what if offered as a “business in a package” that allowed Partners to succeed “without doing the work.” Spot Option similarly said that its package “generates great revenues with minimal efforts as most of the work is done by the Spot Option team.” Spot Option also touted to prospective Partners the profitability of the business by noting that the average investor lost 80% of their investment within five months.
Again, “the average investor lost 80% of their investment within five months” means “you get to keep at least 80% of the money you raise after five months.” The binary-options operator is not running a market-making business, matching customer buys and sells; nor is it hedging the binary options in the market for the underlying stock. It is just taking customer bets, paying out the ones that win, and keeping the ones that lose. They mostly lose.
They mostly lose because Spot Options’s software sets the terms of the bets, and it makes sure the terms include a large house edge:
Spot Option determined and structured the key terms of the binary options offered and sold through its platform. Specifically, Spot Option’s platform provided investors with a choice of: (a) several forms of binary option; (b) numerous reference assets from multiple asset classes, including securities; (c) various expirations; (d) the investment amount; and (e) whether to predict the price of the reference asset would go up (e.g., buy a “call” option) or go down (e.g., buy a “put” option). Spot Option also set the amounts investors would receive for winning trades or would forfeit for losing trades (i.e., the profit/loss ratio), sometimes with the input of the Partners.
Spot Option structured the profit/loss ratio so that on any one trade investors always risked losing more money on an incorrect prediction than they stood to gain on a correct prediction. Spot Option typically set the ratio at a 70% to 85% profit for correct predictions and a 90% to 100% loss for incorrect predictions. Defendants knew that this payout structure made it extremely difficult if not impossible for investors to trade Spot Option’s binary options profitably over time because, on average, investors only won half of their trades.
And because the model of binary options dealers is not really “options dealer” (buy and sell options, hedge in the underlying, try to minimize risk and collect a spread) but rather “Las Vegas casino” (take the other side of every bet, make sure you have a lot of edge, exploit compulsive gambling behavior), the edge could be adjusted to prevent good gamblers from winning too much:
Spot Option’s Risk Management Services allowed Spot Option, on its own initiative or as requested by the Partners, to designate investors as “low,” “medium,” or “high” risk. The risk setting was displayed to the Partners through the CRM software. When investors made too much money, Partners requested Spot to change the investor’s profile to “high risk” to make it more probable the investor’s future trades would lose money. As a Spot Option employee who worked in Risk Management explained to a Partner, changing an investor’s risk level to “high,” “should be more aggressive and reducing his profits in the soon future.”
On November 17, 2014, for example, a Spot Option Risk Management employee informed a Partner that Spot Option’s system had placed a successful trader on the highest risk setting. “We are familiar with the client, he won some consecutive EUR/USD positions on Friday morning and won them all. Our system already put him with highest risk level. Let’s hope he will keep trading.”
Or to prevent bad gamblers from losing too quickly and walking away:
Similarly, the Partners could request that an investor be placed on a low risk setting in the hopes that making profitable trades would induce reluctant investors to trade or trade more, or add additional funds to their account. For example, on July 10, 2014, an employee at a Partner asked his manager to “Please make sure he [investor] is on low risk. I feel he is loaded.” On October 13, 2014, another employee wrote, “please put [investor] on low risk until i resive [sic] more money from him.” On the same day, another employee wrote “put [investor] on low risk need to put more money tnx.” On June 26, 2015, to induce a particular investor to deposit more funds, a Partner emailed Spot Option, “I need this client off high risk because we are getting too many losses and looks bad.”
It really was a turnkey system; in addition to pricing and risk management, Spot Option allegedly wrote its partners’ marketing materials:
Spot Option supported its Partners’ solicitation efforts by providing them with scripts that endorsed high pressure sales tactics and included false statements. Among other things, Spot Option’s scripts instructed the Partners’ call center employees to tell investors that most traders earned thousands of dollars a month trading binary options. For example, a Spot Option training script provided:
“Most <Brand Name> clients produce an income of 1000s of $ / month, just from trading in their spare time on our simple, efficient, and comprehensive platform.” …
“Most of our clients activate their trading account with a small deposit of 4- 5,000$ to start learning how to trade and supplement, and in some cases replace, their income stream.”
And it worked: People put in money, did not take it out, and lost most of it.
Spot Option reports show that, for the period December 2014 through June 2016, on a monthly basis, investors across all Spot Option Partners withdrew only 18% to 25% of the total dollars that they deposited. These documents also show that the Partners’ monthly net deposits (which represented investor losses and Partner revenue), correspondingly totaled approximately 75% to 82% of investors’ total deposits. Other Spot Option reports show that for the period January 2014 through September 2017, on average, investors across all Spot Option Partners lost approximately 72% of their principal investments.
Seems like a good business to be in! Makes sense that someone would franchise it.