Although electronic trading of spot FX has reached unexpected levels, trading of FX options has in the past been stymied by mispricing disasters and recent changes to accounting standards that require derivative prices to be marked to market. But investor appetite appears to be changing. Recent data from Greenwich Associates indicate that among all types of users, average trading in currency options by investors increased from $4.4 billion in 2003 to $5.7 billion in 2004.
“Last year was all about bringing emerging markets to major currency funds,” says Thanos Papassavas, head of currency management at Credit Suisse Asset Management. “This year has been, and will continue to be, about bringing derivatives into the mainstream.”
So there’s certainly room for more growth in these products. While FX options are concentrated in the over-the-counter market, FX investors are becoming increasingly comfortable with trading these more complex products online. But for FX participants to remain competitive in derivatives, the types of tools and products available must be as efficient and diverse as possible.
UBS and Deutsche Bank have historically led the way in e-commerce, but other banks and non-bank providers have now recognized the need to beef up their offerings and increase the complexity of the options products they offer online.
User-friendliness remains a key strategy. This includes integration into the banks’ other e-platforms so that multiple legs are avoidable. Dealing streamable prices in a clear, point-and-click style is now the minimum requirement for investors.
JPMorgan plans to phase in its e-trading platform over the next quarter and early in 2006. “In the long run, we envisage that the majority of our volume will be done online,” says Frank Rawlins, European head of currency and metals trading at JPMorgan. “It will be similar in scale to the spot market but it will be ease of price comparison, speed of dealing and STP [straight-through processing] that will be the drivers of volumes.”
HSBC cites leveraged investors and hedge funds as key drivers of its FX option volumes. While it’s now seeing 60% of ticket volumes traded electronically, it also recognizes how important it is to offer clients the full range of products. “FX options are a different animal to spot,” says Don Lee, head of FX derivatives for the Americas and global head of FX exotics at HSBC. “Many banks have varying capabilities but they all broadly split customers into corporate, institutional and private clients. Each client needs many different solutions and ways to execute options. Electronic trading will only suit certain trades.”
The biggest challenge for the banks is getting business from corporates. “Corporates are becoming more sophisticated, which makes it easier for banks to put forward ideas and products,” says Jason Henderson, global head of FX derivatives at RBC Capital Markets. “What we’re are really trying to do is match our capabilities with their needs.”
Andy Baxter, global head, private client and programme trading in the London currency options group at HSBC, says: “Relationships are vital with corporates and therefore we need to develop online tools to support their individual needs. For example, tools such as hedging conversations and ‘what if’ scenarios have been well received. Corporates aren’t buying standard contracts, they’re looking for solutions. Once solutions-based analytics had been launched we started to work on electronic options trading, the first phase which has recently been released on the same platform.”
And it’s not just banks that are moving in this direction. Futures commission merchant Oanda, which offers FX trading and information services over the internet, introduced a new tool called Oanda BoxOption last month. Traders can now use a computer cursor to draw boxes around expected future price targets on a graphical user interface, request an instant price quote from Oanda, and then buy the option when they want. After purchasing the option, customers can watch the exchange rate progression in real time. The customer’s return is determined by the size and position of the box – the lower the probability the box will be hit or missed, the higher the return. If the exchange rate crosses a hit-box, the customer receives the fixed return for each $1 invested. There is no return if the exchange rate misses the hit-box. Conversely, if the exchange rate doesn’t enter a miss-box, the customer receives the return.
It has set a new precedent in the FX options markets, as FX options have traditionally been traded on an inter-day basis. This tool means that customers can now trade options on an intra-day basis. “This is the first and only product of its kind in the financial marketplace,” says Michael Stumm, president of Oanda. “BoxOption provides both professional and private investors with a powerful new derivative for which they can do any number of things, from hedging exchange rate risk and currency positions to direct investing in the movement of the currency markets.”
With more sophisticated clients benefiting from the increased price transparency that online trading brings, options will remain a key area of focus. FX service providers are in a strong position not only to increase the complexity of the products they offer online but also to tap into new pockets of emerging-market derivatives. “It’s a relationship game at the end of the day,” adds RBC’s Henderson. “Whoever gets in and forges relationships first has the single biggest advantage. New customers are a new source of revenue and, at the end of the day, that’s what we’re all chasing.”
