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Banking

Options pricing: Options open up

Barclays believes there’s plenty of room for growth, helped by streaming prices on its own trading platform.

Options are frequently the best way to manage any type of financial risk. So those with foreign exchange exposure are fortunate that the FX options market is arguably the most sophisticated in existence. A vast range of products is available and new, bespoke options are regularly created.

Despite this there have been numerous occasions when corporations in particular have reported large losses as a result of not hedging their FX risk. For instance, UK conglomerate Anglo American was able to calmly announce that $578 million had been wiped off its profits in February 2004 because of adverse FX movements. Hardly anyone raised a comment at its profligacy; this has not proved an isolated incident and the shareholders of many other companies have had to tolerate similar FX risk mismanagement.

Deterrence

There are several reasons why many operations with FX risk have chosen not to hedge efficiently. The market trades predominantly in the over-the-counter environment, which at one time made it opaque; options are sometimes mistakenly considered expensive compared with simple transactions such as forwards; derivative positions are more complex to manage. Perhaps most important, the imposition of stringent accounting standards such as FAS 133 in the US and IAS 39, which require among other things that derivative positions are regularly marked to market, have all combined to deter use of options.

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