Investors favour weekly FX options amid macro uncertainty
Risk managers have made use of exchange-traded FX options to hedge foreign exposures this year amid a volatile global macro environment.
Data from the Chicago Mercantile Exchange (CME), the world’s largest regulated FX options market place, show that average daily volume of options contracts is up nearly 50% year-on-year, with 60,300 contracts equivalent to $8.3 billion trading each day.
Electronic trading also extended its market share, growing 65% year-on-year, to contribute 85.7% of all options trading on the CME.
Measured in terms of open interest, or the number of contracts outstanding at the end of any particular trading day, FX options continue to run at year-to-date highs with 840,000 live positions, some 70% higher than the same time last year.
While the global derivatives regulations start to push FX swaps liquidity out of voice-brokered OTC markets onto relatively more transparent electronic exchanges, macro-market events are apparently accelerating the use of FX options, particularly short-dated contracts.
The first big increase in CME options volumes corresponds to the launch of the Japanese prime minister Shinzo Abe’s Abenomics quantitative-easing programme in the first quarter, a policy shift which also boosted OTC FX swaps volumes, according to the Bank for International Settlements.
“The increase in options volumes this year was initiated by market expectations of yen weakening versus the US dollar related to the Abenomics,” says Craig LeVeille, executive director of FX products at CME group in Chicago. “What’s interesting for the broader market, however, is that one might expect volumes to come down as expectations evolve. In fact, options have maintained very strong activity as uncertainty around macro-trends has persisted.”
Although the dollar has gained 17% against the yen since the start of the year, most of the move occurred in the first half, with the pair remaining relatively range-bound since mid-summer. Accordingly, USDJPY options volumes have fallen. However, options demand has shifted into USDEUR, USDGBP and, to a lesser extent, USDAUD products, keeping overall volumes elevated.
Short-dated products, specifically options contracts with a maturity of one week, are particularly well-bid as investors adopt a short-term view around economic announcements after the interruption to key monthly economic releases caused by the US government shut-down in October.
“Prior to the shutdown, no one anticipated that the non-farm payrolls would be delayed in October,” says one market source. “As soon as investors learned that the government would re-open, we have seen them make increased usage of weekly products, which benefit from relatively attractive pricing, and strong liquidity.”
Weekly options exercise into the nearest quarterly future, allowing for relatively simple hedging and exit.
According to the CME, volumes of weekly options have increased more than 290% versus 2013 and nearly 900% versus 2011 on an open-interest basis.
The sustained increase in options usage this year, as indicated by the open interest, is particularly noteworthy given the overall reduction in OTC FX trading activity and generally lower FX volatility.
“Investors are uncertain about holding large 100 delta positions in FX right now as they don’t have a clear picture on where markets are heading,” says LeVeille. “General murkiness about quantitative easing and its potential impact on the emerging-markets complex means that investors need a tool that allows them to express non-linear views, to quantify risk and maximize participation. Options can achieve that.”
Indeed, a closer look at the numbers shows how markets are positioned for the immediate future, with some interesting patterns around EURUSD indicating where investors see value, after an ECB meeting in which the potential for negative euro rates was discussed.
LeVeille points to a Euro FX Call option with a strike set at 1.35, which expires on December 6, that has amassed 13,462 open-interest equivalent to $2.25 billion of risk. A euro put option with a 1.32 strike and the same maturity date, meanwhile, has $1.2 billion of open interest against it.