What factors are driving the push towards more automation in FX options?
The push towards automation is inextricably linked to conversations around cost. Banks – especially tier 2 and tier 3 institutions – are struggling to reduce their cost to income ratio. One of the largest expenses for any trading operation is the headcount, and automation can help to facilitate growth of volumes without the associated headcount inflation. Whereas 20 years ago a single person might be responsible for a specific trading instrument now that same person can cover many different products. With smart automation trading staff can increase their productivity substantially by focusing on the key rather than the vanilla operations.
In what ways do you think the COVID crisis has accelerated the use of electronic FX option changes, especially on the buyside?
The changes have stemmed from both direct and indirect consequences of the pandemic. Directly the pandemic has caused massive disruption in the world’s supply chains. With traditional suppliers unavailable due to lockdowns and trade restrictions, there is a greater need for hedging of currency risk exposure.
Indirectly we have seen large currency movements and wider spreads reinforcing the need for good hedging and risk management strategies. More broadly during the pandemic, we have seen the results of years of education and knowledge sharing on the use of more sophisticated instruments such as swaps, NDFs and options. For example, on the buy-side, more managers both understand and are now implementing comprehensive risk strategies. The combined demand from corporates and investors has further pushed the development of this market, which has been in a multi-year trend, crystallizing this year.
What technical difficulties have made the development and adoption of dedicated electronic FX options relatively slow?
“Options” is a huge product category that contains hundreds of different variants. What is more important than any technical limitations is the ability to realise the return on any particular product development by market participants (LPs’ & market makers). Relatively simple options – the ones that are used hundreds or thousands of times a day – have been available electronically for some time.
Now usage is turning towards more complex, esoteric products and structures. For each individual product variant, one must decide whether the volume exists to justify development. For example, it’s a much harder case to make to justify the ROI for a product that trades only once a month. One barrier that has been removed is the concentration of pricing data siloed in SDPs at the largest investment banks. As pricing data is distributed more widely through standard APIs, it allows other buy-side, corporate and other financial institutions the ability to access and trade options based on that data using the platforms of their choice.
smartTrade is uniquely positioned to accelerate and disrupt the way options are traded by enabling electronic execution, direct sourcing from the main players, and aggregation combined with a transparent and efficient commercial model. As prices are sourced directly from the Liquidity Providers there is no overhead of traditional brokerage fees or any hidden costs, options traders can now take advantage of technology without paying a premium.
Trading options electronically can also lower overall trading costs as customers avoid the cost associated with traditional brokerage fee platforms. smartTrade’s subscription-based fee combined with price aggregation for option trading generates meaningful savings across an entire trading lifecycle.
In what ways are the need to demonstrate best execution pushing migration towards platforms with richer functionality?
Banks are increasingly accountable for the actions they take on behalf of clients. They need to have records, and the data to back up the rationale behind why they made certain trades at certain prices. The core principle of a number of major regulatory reforms including the FX Global Code, of which smartTrade is a signatory, has been affirming and emphasizing the duty of care banks have for their customers to achieve best execution using appropriate methods and products.
This has led to an environment of greater scrutiny and in turn led to the development of platforms that can easily and automatically provide that information to relevant market participants. Clients are increasingly discerning in selecting partners that have all necessary features and functionality to achieve this goal.
In what ways are leading technology providers working to make electronic FX options trading a much easier and less complex process?
First and foremost, provide simple tools to use that are easily recognisable to traders and end clients. It is important whenever possible to offer the user interface and jargon that is familiar to users. smartTrade options trading platform shares the interface and user experience design principles common to the rest of the FX trading platform.
Rather than having to learn an entirely new set of procedures, now there is a new box that looks much the same as what traders would see in other assets classes, such as traditional FX. We believe as much as four fifths of overall functionality and flows are very similar – if not the same – across asset classes. While there are always a few, asset specific workflows that need to be incorporated into a product, our emphasis on a standard interface allows smartTrade to leverage its existing tried and tested components when expanding into a new asset class. This reduces risk in the product development cycle and lowers time to market. For the introduction of FX options, end-clients on our existing FX trading platform have less to learn, which means reduced cost of implementation, less training time, and lower operational risks.
What is being done to develop more end-to-end trading workflows?
The widespread adoption and distribution of standardised APIs have massively expanded the industry’s ability to create easily integrated workflows. Now data can easily flow throughout the trading process in a simple and more automated process. As for what’s on the horizon, we will certainly see additional options products. smartTrade has already implemented vanilla calls and puts, along with straddle, strangle and risk reversal and spreads. Based on client demand we plan to add support for more exotic option types and integrate additional distribution venues.
In what ways is FX options liquidity optimisation helping to improve the functionality of electronic platforms?
Liquidity optimisation is the ability for someone to access the best liquidity available at a fair price, in sufficient quality for their needs and in a timely manner. Before the widespread availability and deployment of liquidity optimisation, customers were dependent on the ability of liquidity providers to distribute prices on demand; something that could be time-consuming and only done so often without moving the market. Liquidity providers need to set prices where they know they can make a margin, which leads to greater concentration in traditional products where there is less chance of mispricing. The overall effect for both sides is more sustainable relationships and better risk management.
Why is smartTrade uniquely placed to cater for the needs of multi-asset class traders who are also looking for FX option trading solutions?
smartTrade’s roots have always been in the liquidity management business. Since its inception 20 years ago, the company’s mission has been to provide technical access to extensive liquidity sources and distribution venues for clients. That mission has never been confined to a single asset class. smartTrade as an organisation is consciously committed to a multi-asset design policy that enables the support of cross asset functionality at a deep, scalable, and reliable level.
The trading infrastructure for all asset classes are hosted in the same data centres, using the same underlying low latency, fully redundant infrastructure. Options were the logical next step on that journey. smartTrade works with customers who trade FX and Fixed Income every day. Market and macro forces, as we highlighted above, are pushing them to increasingly consider and implement options strategies. smartTrade offers customers the ability to trade options with their trusted providers, using the same level of care and expertise clients have experienced for years.
As FX options flows increasingly migrate to execution channels, what’s next for automation?
For smartTrade, post trade and option hedging strategies are the next frontier. We want to develop automated rule-based options for transaction execution. Do you want to exercise the option or not? Do you need physical delivery? What is currently being done inside post-trading systems at banks could be absorbed into an end-to-end system.
On the hedging side we see clients and banks automatically linking delta hedging workflows. We also could see distribution automation of more complex option types such as the next generation exotics. The market’s not quite there yet, but this is definitely the direction of travel.
As we look to the future, what additional features might become more widely available?
Features right now exclusive to the very upper end of the market will filter and diffuse throughout the wider market becoming more widely available to all users. Exotic options with unique payment structures, expiration dates, and strike prices, along with multi-leg options, should spread, along with axe displays that make it easier to show interest.
We also expect wizards that can automatically construct options structures to achieve specific risk management or profit outcomes, along with actionable volatility spreads and algo options to become more prevalent in the future as the market matures. The scope for innovation and development in this market is endless and we are excited to be leading the industry in this direction.