FX comment: Ban on naked currency option short positions – Merkel reviews the options
Following last week’s unilateral ban on naked shorting of sovereign debt, associated credit default swaps and top-10 German financial stocks, German chancellor Angela Merkel’s finance ministry leaked draft proposals to extend the ban.
Apparently, an extension of the ban is being mooted that would encompass a ban on short selling of all shares and, bizarrely, euro-denominated currency derivatives. Quite what the German authorities think they will gain from such market-disruptive nonsense is hard to fathom.
How might a ban on naked currency option short positions possibly work? Ignore, for a moment, the fact that it is at present only the Germans that are suggesting this and imagine that the ban is implemented globally.
Optionality is a strange beast: an option may have an underlying but the only way to truly hedge a short option is to buy an option with exactly the same strike and expiry. Under a short-selling ban, if a market-maker hasn’t got the required option on his book, he can’t sell it; and the customer will have extreme difficulty in buying one.