Many 'investments' are just plain gambling

How would you feel if a financial professional offered you the chance to make money in a new and quirky way? Most people prick up their ears at an opportunity with big potential returns.

But when is an investment not really an investment at all?

I'm going to call this one the "Horsey-Option". In real life they're known as "binary options", "all-or- nothings" or "digital options".

Horsing Around With Returns

First up, we have our asset: a horse in a fenced paddock with a bale of hay and a water trough. If you pick the direction the horse moves correctly you get a big return. Muck it up and I keep your money.

Trade 1. Will the horse step closer to the fence in the next two minutes? Pick the right direction and get your money back with a 90 per cent return.

Trade 2. How about a return based on the horse touching the fence in the next hour? That will see your capital repaid with a 200 per cent profit on top.

Trade 3. Would you invest based on the horse staying within five and ten metres of the water trough in the next 60 seconds? 500 per cent return on this one.

Trade 4. A staggered payout perhaps? If the horse touches the hay bale within five minutes, you profit. It then drinks from the trough within 10 minutes and the profit increases. There's a whopper payout if it goes on to touch the fence within 15 minutes. The triple-dip.

Trade 5. We put a horse and a sheep in the same paddock. Which one of the two will be closest to the fence in 15 minutes time? Even if they both step backwards, one will be closer, so you don't have to worry about the direction.

No, it's not doing it for me either. You'd probably rather buy a bucket of manure.

So why is it, that when we add some legitimate assets, a bit of jargon and a website, people start trading? An investment this is not. It's betting pure and simple. There is a complete loss of capital if you fail to pick the right direction.

A high/low binary option on the price of gold rising in the next two minutes is our horse stepping towards the fence.

A one-touch binary option on Proctor & Gamble shares hitting US$90 in the next three hours is the horse touching the fence.

A tunnel or range binary option on the FTSE 100 trading between 7200 and 7300 is the horse staying within five and ten metres of the water trough.

A ladder binary option locks in partial payouts if the asset moves through a series of different prices. That's our horse touching the hay, the water and the fence.

A pairs binary option is the jargon used to compare the performance of two different assets. Will the Australian dollar perform better than the euro? This is the analogy with the sheep or the horse getting closer to the fence?

Binary options are legal financial products in New Zealand, although they were banned in Belgium and Israel recently with many other countries weighing up whether to follow suit. The French have banned all electronic advertising. In the United States they can only be traded on a regulated exchange such as the Chicago Board Options Exchange (a very high barrier).

My view is they are nothing more than online casinos. Some have been associated with identity theft and scams.

Options or "derivatives", as they are known, are legitimate risk management tools for controlling exposure to price movements. But binary options have taken this market to the level of sports betting.

How the quoted returns relate to the Black & Scholes Option Pricing Model, I've no idea. In the derivatives world we talk about the volatility smile and smirk. There will certainly be a bit of that going on in these internet-based bucket shops.

The Financial Markets Authority (FMA) only licenses operators with trades lasting longer than three days. That means this market is almost entirely unregulated.

If it looks like a bet and it smells like a bet, it would probably be better handled by the Department of Internal Affairs (DIA), with levies taken for problem gamblers. That's more of a snipe than a serious suggestion.

At the very least, the word "investment" should be banned.

The FMA is certainly concerned. Read their list of warnings at www.fma.govt.nz. It makes fairly eye watering reading for a regulator.

They don't quite throw a bucket of manure at them, but it comes close.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.