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While online traders have enjoyed increasingly impressive access to FX Spot liquidity in recent years, when it comes to FX Options, they are just getting started. The FX Options market is enormous. For the most part, this huge options volume is transacted by relationship banking.
The largest institutions are offered options liquidity by a number of major banks, settling trades directly or via prime brokerage. Corporates, smaller banks, and some other institutions can trade with their liquidity providers via the handful of single-bank portals of varying quality. Until recently, options trading has been stuck where spot was ten years ago, when non-institutional traders had no access to tradable prices, and the online margin FX business was born. Brokers with their own trading desks and access to bank liquidity are getting geared up for options trading, or are outsourcing their execution to options trading specialists.
They are offering platforms complete with streaming options prices as well as risk management tools and analytics, something the banks have never offered.
A handful of brokers offer ECN pricing on the back of their multibank liquidity, passing the best bank price on to their customers, and can even offer retail sized trades that could never be passed directly to a major bank. For ten years, online trading of options has lagged spot FX, as dealers have been falling over themselves to provide the spot liquidity traders want, while brokers have been busy educating new legions of traders.
These traders have come a long way in this time; spot trading has become commoditized and leverage has been limited by regulation. Traders are now educated technically and technologically, and are looking for new tools to express their market views. Brokers are finding themselves under pressure to provide answers to demanding customers at every level.
Many of these customers are not new to options trading at all; they simply have not had access to the FX variety. Options traders are active at every point of the equity options market, from retail to institutional; when shown that they can employ there options skills in the FX market with streaming, online, 24 hour trading, most are amazed at the liquidity on offer and are eager to diversify their trading with a new asset class, currencies.
With the largest banks investing in their technology after a difficult few years, and with the growth of institutional RFQ trading, suddenly both the supply and demand for online FX Options liquidity has grown.
Should every trader consider using FX Options? Very simply, options offer asymmetric payouts, allowing traders to create risk profiles to match just about any market view. Without options, spot FX traders are limited to long and short positions, with their potential for unlimited gains and losses. Their only tools are limit and stop orders. Options change the game completely, allowing traders to take unidirectional views with known worst case outcomes, or to get paid for taking risk that otherwise would have been left unmonetized, given away to dealers for free.
Consider the simplest case of a trader with an existing very profitable spot position. Without options, he can only leave a sell stop below the market. But with options, he can use some of his profits to buy a Put option, protecting his downside. An intervening dip in the spot price that would see his stop order filled is of no consequence to the options trader, whose position will remain in place to profit from a subsequent rally. Perhaps the greatest argument in favor of using options comes from selling options.
What is a a spot trader to do if he expects a market to be range bound for the coming month? He can buy on dips and sell into rallies to earn a few pips here and there.
He can sell combinations of calls and puts, getting paid for the protection he is offering others. The premium he earns is hard to replicate by the spot trader. Both the spot and options trader can get the market wrong, but in the case of the options trader, he can only lose on one side, while having earned premium from both the call and the put. With options in his arsenal, every fund manager has a more complete set of tools to trade the market. Online brokers have been challenged to offer options trading to date.
Even with third party options platforms, most brokers are not staffed to manage options flows. For many, expected options volumes might not warrant hiring a complete options trading team. With new technologies and services offered by options specialist firms, any broker can now complete its FX product suite, offering customers professional access to the largest options market in the world.