Just one month ago, the Bank for International Settlements published its triennial survey, accounting world wide FX options daily averages turnover to USD 117 billion traded in April 2004. A mere 195% increase over the 2001 comparable period. Even though part of the gross is reflected by the USD global weakening, undoubtedly OTC FX options is a growing business.

Company globalisation with product prices competition, as well as alternative asset management emergence is giving another dimension to currency options trading. Every risk is assessed, covered and none of the FASB 133 or IAS 39 rules will divert its path. Derivatives knowledge is better spread and shared among the players. The shift from forward rate price to option structures is more obvious. FX options providers have well understood where their interest lies with such a high margin product. Banks are making lots of efforts to support the buy side on FX options trading by supplying accounting methodology and discussion with customers auditors.

During the internet booming years, banks started offering FX spot trading and gradually included options on their platforms. The main idea was to give the buy side an alternative way to trade with them, figuring this would increase their FX business flow. They considered building in-house or purchasing an existing front end such as AVT. To be among the first ones to offer this service lots of them selected the second solution. The main problem was that the buy side was not seeing any kind of difference between the Bank A or B spot trading platform, with the only noticeable change being the banks logo (assuming the bid/ask spread linked to their corporate rating was equal).

Benefits of an electronic Options trading platform We might therefore consider what are the real benefits of being able to offer such an eFX platform? There are several answers. On the banks side, they can offer the same pricing interface to their sales, regional offices, non FX specialised department and their customers, such as institutionals, corporates, hedge funds, high net worth individuals etc and reduce at the same time all the processing costs and misleading typing errors.

Over the phone, a 200 k nominal ticket represents the same work processing amount than a 10 Million one, but does not generate the same mark up. So which one would you think the bank prefers to trade?

Thanks to technology and STP (Straight Through Processing) positions traded generate electronic confirmation, going into the traders book and directly into the customers account (who can eventually split it in different accounts). Small nominals can be directly traded either by customers or sales without any trader intervention. It also brings more liquidity thanks to higher volume and a 24/7 access. The trading platforms are not subject to emotional pressure via competition. Banks can also monitor their customers platform usage and even propose to them adapted FX options structures. To benefit from technological advances and amortize huge development costs, top tier banks are even white labelling their own solutions to smaller banks via various formulas, lending new capability to smaller players and being rewarded by business flows. The larger your flows are the smaller is your risk and you could end up earning the spread.

On the buy side, you may find fewer advantages. You can at any time get a tradable price on RFQ basis even if it is not the best one. You can request as many quote ask you want without bothering. Supposedly, the trading platform might not know you as well as your Sales person and which side you are coming for.

Should you opt for a prime brokerage solution like hedge funds are, you could get transactions with all your chosen counterparties for ten US dollars processing cost per Million US dollars traded.

Limitations of an electronic trading solution
An eFX platform certainly offers flexibility but you may find some limitations. Customers cannot price any kind of FX options package (especially exotics) on any currency pair or maturity or run some analytics on its behaviour or re-price them on there own market data.

If you compare voice services to electronic ones, you end up appreciating the answers obtained from your sales people, options specialist or trader, with whom you can very easily trade any kind of sophisticated structure. Are there any tangible reasons why eFX platform functionalities and offered products are so limited

Exotic options price calculation is really the trickiest, tedious and difficult part

To find the answer you have to get a better understanding of the process. First you need to have a sophisticated enough risk management system to check the customer credit line availability at any time and before any trade. Then you have to calculate the price of the option package you want to trade. Consider a windows Forward zero cost package including a monthly strip of 10 days windows RKO over two and a half years with a 5m USD leg nominal, its not an easy one.

Exotic options price calculation is really the trickiest, tedious and difficult part as second derivatives risk management is involved. You have to take into account a great number of parameters such as currency liquidity, gamma, Vega, over hedge costs, position replication, volatility structure as well as traders overall books exposure.