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Foreign Exchange

Operational risk in exchange-traded options – FX is so much better

I was amazed recently to learn that the accidental exercising of deep out-of-the-money options on the regulated exchanges is a significant problem and, apparently, keeps many operational risk managers awake with nightmares.

Despite all the advances that have been made in automating the deal chain, the practice of exercising and also, I hear, of “abandons” – where in-the-money-options are strangely not exercised – is still an extremely manually intensive process. There are many reasons why this might be the case, including the fact that the exchanges have slightly different rules about automatic exercises and also perhaps because a lot of the options traded are American-style.

No doubt these processes will all be improved but I simply can’t believe that out-of-the-money options not only get exercised but that the deals don’t get cancelled when it happens. I think the FX market should give itself a pat on the back for its professionalism about how it handles this issue. In FX, reputation is paramount. It makes me wonder whether some players in the exchange-traded arena use the fact that they can hide behind an anonymous central counterparty to indulge in less-professional practices.

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