FX Options: A sensible way for traders to navigate the Brexit period and manage risk?

Ever since January 2015 brought its now infamous ‘black swan’ event in a sudden flash of volatility into the global currency markets as a result of the Swiss National Bank having removed the 1.20 peg on the EUR and CHF pairs, the risk management departments within brokerages have taken very extensive risk management measures.

From a trader’s perspective, however, many retail market participants have drawn a line of caution, having to put their faith in the products offered by brokerages.

Most certainly, whilst the impending referendum on Britain’s continued European Union membership is a known forthcoming event, rather than a completely unexpected circumstance as per the Swiss Bank’s action, however the uncertainty with regard to the currency markets and the future landscape of the electronic trading business in Europe following the counting of the votes on June 23 is a reason to take a look at risk management.

In this case, traders can, whilst having to consider the risk management policies of their brokers and have faith in them, choose to trade FX via a means other than spot transactions.

Options and futures are one particular avenue, and companies providing contracts that would have originally been the preserve of the large proprietary trading firms of Chicago are now angling their product ranges to attract retail customers.

Today, FinanceFeeds spoke to James Friedman at FxBRIDGE, who explained “I spoke with a broker who is talking to folks about how to handle the upcoming referendum. He says that he had “been having these conversations with some of our larger clients already but vols seem to be so high for the event that they are reluctant to get involved… we’ll see where it goes.” I asked, “Aren’t you glad your parents didn’t wait to see how things would turn out before deciding to have you?”

Mr. Friedman continued by explaining “I’m sure smart people stayed out of crude oil at $60 because it was too expensive and then it ran to $130.”

“Personally, I have no interest in speculating where the market is heading. All I care about is the marketing value of a news event and whether it will drive more business. I can assure you, more speculators bought gold in 2010 – 2013 because the price went up over $1,800 than they do now at $1,200. That’s the whole point. And with more players in the market, there’s more likelihood that pricing is not built by cartels but reflect the sentiment of the market” he said.

In concluding, he presented two points of interest from his perspective which are:

1. If it’s not the Greek crisis and the PIGS, it’s the Swiss Central Bank, or Scottish independence, or BREXIT or the next president of the United States or whatever is coming next. Something will always happen whose outcome is unknown to the market.
2. Options and spot are a better way to trade volatility than spot alone.

A few months ago, Ryan Hansen, President of Tradovate explained how the electronic execution of retail futures platforms are now open to retail traders who are nowadays not faced with the same costs as they would have been a few years ago when exchange membership and clearing fees were strictly the preserve of the commercial trading enterprises.

“There used to be a reason that this was done differently in the past, as used by firms that operate a commission model. The old way of doing business where a human touched every aspect of an order at multiple stages is no longer relevant, it went through a process in which a customer called a broker, then the broker called the trade desk, then the trade desk called the trading floor, the trading floor then transacted the order potentially with a market maker. The trade was then reported back. This required a lot of manual work” Ryan Hansen, President, Tradovate.

“With electronic trading, the costs created by the manual element are no longer the case. “For example, 1,000 contracts could be executed, or just 1 contract could be executed, and there would be no extra work for either scenario” he said.

“Traditional brokers charge a commission on every single contract. We charge a membership fee that covers the technology cost and the brokerage in one.”

In terms of connectivity to venues, Mr. Hansen confirmed that Tradovate is connected to CME Group (which includes CME, CBOT, NYMEX and COMEX), ICE US & Europe, and Eurex derivatives exchange.

An interesting matter to consider with regard to the capital position of customers vs the leverage with options customers is that the deposit balances are often considerably higher, meaning that the margins are higher and the risk is lower, and also there is far less counterparty credit risk due to the centralized exchange processing orders and the leverage conditions.

A very interesting perspective, and certainly worthy of consideration.