The derivatives specialist has ambitious plans to modernize the way exotic FX options are traded on its new platform, SDeX, but is the market ready to trade such complex structures electronically?
FX options are a niche part of the overall currency market, exotic options even more so. The vast majority of currency transactions are either spot trades – a simple exchange of one currency for another – or FX swaps, which are a spot trade plus a forward.
| Just when you think volatility has |
it comes back with
FX options are classified as derivatives and represent a much smaller, more complex part of the market. The most basic options are referred to as vanillas, while more complex multi-legged structures are considered exotic.
According to the Bank for International Settlements’ triennial survey in April 2013, options accounted for just 6% of daily FX market turnover.
Despite the highly electronic nature of FX trading, exotic options are by and large traded over the phone, due to the nature of their complexity. They can be priced electronically, using pricing software from the likes of SuperDerivatives, but are still mostly voice traded.
It is possible to trade vanilla options and some exotic structures on single bank platforms, exchanges and multi-dealer venues, such as Bloomberg Tradebook, but exotic options have yet to join the electronic revolution en masse.
SDeX went live on August 1, allowing market makers and takers to price complex options and then trade them, says David Collins, chief executive of SDX Trading at SuperDerivatives.
“We previously offered the ability to price options indicatively, but it was not possible to go out and trade those options,” he says. “People would use the indicative price to negotiate a better price when trading with their bank, either over the phone or on an electronic platform.”
SDeX aggregates prices from several banks on one platform, to help traders save on “screen real estate” and from retyping their request into several different bank portals to find the best price.
Collins believes this is a crucial part of the offering, since traders are now turning to multi-dealer platforms ahead of single-dealer venues, according to the Bank of England’s semi-annual FX turnover survey results for April 2014.
It showed that volumes on multi-dealer platforms rose 15% since October 2013 and 4% year-on-year to hit $362 billion a day, compared with $309 billion a day on single-dealer platforms, which represented an 8% fall from October 2013 and a 16% fall year-on-year.
Twenty-eight banks have agreed to be market makers on SDeX, including Goldman Sachs, Credit Suisse and RBS, as well as local currency specialists such as Turkish bank Akbank and Hungarian bank OTP.
SDeX customers can choose how many market makers to request prices from and either receive an automatic price via an API or a manual response, whereby a salesperson or trader will carry out a credit check and send back a price.
The platform offers automatic pricing for vanilla and first-generation options, but more advanced options are likely to be picked up by the bank and quoted manually, says Collins.
It’s good to talk
The truth is that customers still prefer to discuss exotic options over the phone and negotiate on price, says the chief executive of a rival trading platform and registered swap execution facility.
“People use electronic tools to price [exotic options], but when it comes to trading them people like to negotiate and ask questions,” he says. “They like to do those complex trades with human beings.”
To that end, the creators of SDeX introduced a counter-offer function. If a customer is unhappy with a quoted price, they can submit an alternative price and see whether market makers will accept.
Equally, market makers can see how competitive their pricing is with a traffic light system. A bank with a red light can withdraw its price and re-quote up to two times, to be more competitive.
“This function is helpful when pricing less liquid or more complex trades and helps the price requestor get the best price,” says Collins.
The platform boasts some interesting functions, but SuperDerivatives has chosen to launch at a time of historically low volatility. FX trading volumes are down, particularly options trading, as people are less inclined to buy protection against moving exchange rates when they show little to no sign of moving.
Collins is sanguine about the timing.
“You can’t choose the markets,” he says. “Markets have been quiet for so long, a general apathy seems to have come over the foreign-exchange market. But just when you think volatility has gone forever, it comes back with a vengeance.”