Similarly, paying out 1 unit of the foreign currency if the spot at maturity is above or below the strike is exactly like an asset-or nothing call and put respectively. Hence if we now take , the foreign interest rate, , the domestic interest rate, and the rest as above, we get the following results.In the standard BlackScholes model, one can interpret the premium of the binary option in the risk-neutral world as the expected value probability of being in-the-money unit, discounted to the present value. The BlackScholes model relies on symmetry of distribution and ignores the skewness of the distribution of the asset. Market makers adjust for such skewness by, instead of using a single standard deviation for the underlying asset across all strikes, incorporating a variable one where volatility depends on strike price, thus incorporating the volatility skew into account. The skew matters because it affects the binary considerably more than the regular options.A binary call option is, at long expirations, similar to a tight call spread using two vanilla options. One can model the value of a binary cash-or-nothing option, C, at strike K, as an infinitessimally tight spread, where is a vanilla European call: 22 23The MFSA has just published its policies on the licensing of binary options trading operators. Apart from the standard rules applicable to Investment Services Licence holders, these additional policies ensure that enhanced safeguards are in place, taking into consideration the complex nature of binary options, the high risks associated with them and the accessibility of such products to retail investors.Applicants intending to offer binary options trading services must apply for a Category 3 Investment Services Licence, which is a licence that would allow the licence holder to provide any investment service and to hold clients money. This licence also permits the licence holder to deal on own account.The MFSA would expect the promoters behind the application to have an established track record in the industry, previous operating experience within a regulated environment and a good track record in handling consumer complaints, amongst others. This approach ensures that any applicants for business coming to Malta are adequately prepared to operate within a regulated environment which is key to ensure compliance with all the applicable rules and regulations.Of paramount importance is the classification of instruments as binary options which should be in line with the definition of the European Commission that includes, amongst others, derivative contracts relating to securities, currencies, interest rates or yields and derivatives relating to commodities that are settled in cash or that can be physically settled, provided they have the characteristics of other derivative financial instruments.Unfortunately, in the binary options industry, there does not seem to be a uniform definition of what constitutes a binary option and therefore, to determine the actual nature of the instrument, the MFSA will look into the actual substance and not the nomenclature of the instrument.If the instrument falls within the definition adopted by the European Commission, then it can be considered a binary option. Interestingly, the MFSA has also clarified that the tradability or otherwise of an option is not a determining factor in establishing whether an option falls within the classification of instruments and therefore a binary option need not be tradable in order to qualify as such.Similarly, a binary bet based on randomly generated indices created by a companys proprietary software and which is not linked to the performance of any real asset, security, financial index, right, service or obligations shall not qualify as an instrument.The MFSA has revised its previously restrictive requirement that every applicant for business has to have a qualifying shareholding by a licensed entity operating in the same line of business. The position of the MFSA is that if the applicant for business is not already licensed, the MFSA may require shareholding by a licensed entity on a case by case basis, taking into consideration the following:a. The shareholding structureb. The quality and track record of the proposed management teamc. The target marketd. The result of the due diligence investigationse. The capital structure being proposed andf. The level and nature of operational and business risk involved.Therefore this requirement is not automatically applicable but it shall be determined on a case by case basis.These competence requirements also apply to individuals who would occupy senior positions and who report directly to the Board, such as the senior manager, the risk manager or the head of trading. The Board of Directors should also include a local board member based in Malta and an independent board member.The MFSA expects that the core licensable activity of the company is carried out in and from Malta and no letterbox entities purporting to have presence in Malta will be allowed.