The exchange’s options are currently quoted in premium, whereas standard practice in the dominant over-the-counter market is to quote in vol. According to a draft proposal, vol-quoting will initially be available for European- and American-style options in five currency pairs; a sixth pair, AUD/USD will have vol-quotes for American-style only.
New functionality will allow the options to be traded with an auto-hedge into the nearest quarterly month of the underlying. The exchange says this functionality eliminates the volatility-to-premium conversion and constant price modification previously required to trade options volatility in premium markets. The CME intends to run dual markets initially.
One option trader told the Weekly FiX that the CME had made a similar move around 15 years ago when it listed vol options on Reuters. That initiative apparently failed because the auto-hedge was set by the prevailing price of the underlying in the market at the time of the trade; a lack of liquidity in the exchange’s futures, especially in European hours, meant that the price could be scammed. That will no longer be the case given the successful way the exchange has built liquidity in its FX futures over the past few years, although OTC traders may still shy away from the contracts because of the relative complexity of their expiries.