The late 90s saw many banks launch online FX trading systems enabling their clients, internal branches and subsidiaries to log on and trade spot and forward. Users simply selected currency pair and size and, with a single click, executed their trade. Adding margin, checking credit lines and other elements were performed automatically in the background.

This new e-commerce DIY approach suited many buy-side users, while at the bank sales peoples workload reduced, providing the opportunity for them to focus on more value-added activities. As these systems became widespread, efficiency increased and costs were lowered.

In FX, online trading seemed to have stopped at spot and forward. Even now, few banks offer online trading of the directly related FX options market. It seemed a natural next step but many banks were slow to move forward. The reduced e-commerce spending following the dot-com bust definitely played a part, but many banks simply balked at tackling the added complexity involved in trading options online. Also, since options were less liquid and more tailored, it was felt many end-users would not be comfortable trading them online. There was therefore less incentive to automate since the efficiencies made in spot were unlikely to materialise in options.

Options for efficiency
But that was then. Almost a decade on, fuelled by increased marketing of vanilla and, more importantly, exotic options, liquidity has grown significantly. The latest Bank for International Settlements survey, in 2004, found that global daily turnover in interest rate and foreign exchange related derivative products - including outright forwards and foreign exchange swaps - increased by 74% between 2001 and 2004 (51% at constant exchange rates), to $2.4 trillion.

With this increased liquidity of vanilla and simple exotics, end users familiarity with options has increased. This has made them more comfortable with the concept of trading options online. Also, the scale of operations at large sell-side banks to serve this growing customer base has made the business case to trade options online significantly more compelling. A few major banks saw this and were first movers in offering online trading of FX options and have been very successful at it. This competitive pressure and client demand mean that other banks are now looking to offer online trading. How to do this quickly and cost effectively though?

Options essentials
Spot and forward trading platforms require integration with systems covering market data, client reference data, limits and authorisation information, risk management/position-keeping and the back office. But such integration is relatively straightforward compared to what is required for options. Option trading requires mathematical models, interpolation routines and more complex market data such as volatility surfaces, preferably all generated and kept up to date in real-time. This complexity coupled with the nuances related to each of the many possible strategies that can be traded, quickly reveal that the systems developed to handle spot and forward trading are rarely suitable. Separate, dedicated systems supporting option trading are required.

There is more. As clients do not want two separate systems from the same bank to trade the spot/forward and option markets, the new options technology has to be linked to and be integrated with existing e-commerce infrastructure. This is to ensure that items such as login, workflow, branding, etc. are presented in a uniform, consistent manner to the end users.

As easy as API
Including options in an e-commerce platform confronts banks with the familiar build or buy decision. With many banks deciding that building complex IT systems is not - nor should be - one of their core competencies, they are increasingly looking to system vendors who can partner with them in delivering trading platforms to their clients.

Another advantage of the API approach is that it gives banks assurance regarding retaining their own intellectual property.

Key to success in implementing the highly integrated solutions described above, has been Application Programming Interfaces (APIs). APIs allow banks to take vendors software and build links to their own systems, tightly binding the new and existing technologies together and delivering the uniform client trading experience. APIs enable IT departments to deliver integrated solutions rapidly and effectively.

Another advantage of the API approach is that it gives banks assurance regarding retaining their own intellectual property. Much of how banks add value is bound up in the models and methodologies they use to calculate option prices. Using APIs to link their own models and methodologies to vendors trading systems means that there is no danger of them being exposed externally since a banks own development staff can perform the integration.

Alternatively, using APIs makes it easier to augment an internal development capability by retaining the services of a vendors professional services teams who can write interfaces to the banks systems. Whichever route is chosen, APIs are a quick and efficient way to reduce the pain for banks in creating an integrated spot, forward and options trading platform for foreign exchange.

Freed to add value
By using APIs to integrate trading vanilla options with spot and forward FX trading, banks can free their staff to spend time developing relationships with clients and developing products structured to their needs and thereby add value.

These structured products are the new exotics and will not be automatically screen traded any time soon. Banks that use vendors that supply APIs with their trading platforms will find that their staff spend less time on technology and more time on meeting clients ever more complex needs.