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New convention for interbank options

The interbank options market has changed the way option premia are calculated.

Sources say that too many disagreements on where depo rates were had begun impacting on liquidity. The problem has increased as interest rates have moved towards zero – because any discrepancy has a greater impact on the net present value of the premium. “Post Lehman, with depo rates becoming wide and, according to the forward traders, ‘not quoted anymore’, there has been a lot of disputes in agreeing option premia between banks. This led to games where banks would try to set a high depo if they were buying an option and vice versa. A higher depo rate will lower the premium to be paid for delivery on value spot,” says one senior options trader.

The move was initiated earlier in the year by brokers and as of yesterday (Thursday), the interbank market moved to a forward premium convention. It seems that it will be some time before the buy side adopts the protocol and apparently a few banks’ systems can’t yet make the change. In a message sent to clients, Barclays says: “We will continue to provide spot premium pricing to clients as a default, but if a client requests that they want to move to forward premium pricing, obviously we can accommodate.

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