It has been over six months since the COVID-19 pandemic hit the global economy and sent financial markets into one of the wildest rides ever seen. Extreme market volatility was seen across all markets with unprecedented markets dislocations. With the Fed’s intervention, by announcing QE Infinity in March, financial markets have since embarked on a dramatic turnaround. Gold and Nasdaq both hit all-time highs, while yields dropped to rock bottom. The FX market also went on a roller coaster ride. The DXY Dollar-index made a big reversal since its near 9% spike in March mainly driven the Fed’s relief measures, the eurozone’s agreement to a EUR 750 billion pandemic fund, and the escalation of the COVID-19 spread in the US.
Despite the rosy picture painted by the financial markets, we are still facing a lot of uncertainties in the coming months. We still do not know if the global economy is able to turn around from the near knockout blow. Key risk events ‒ such as timing of the release of an effective vaccine, November’s US Presidential election, and the escalating tension between the US and China ‒ continue to cloud the markets. Such uncertainties do mean one thing ‒ market volatility will remain elevated. Both historical realized and one-month at-the-money (ATM) implied EURUSD FX volatilities are hovering near 8%, which is almost double that of pre-COVID-19 levels. This presents opportunities in the FX and FX vols markets for us. Interestingly, over the last five years, the one-month ATM implied volatility has been leading the realized volatility observed in the market. Current market positioning is also very heavily tilted to short USD, as reflected by the open interests of asset managers’ long EUR/USD positions hitting record highs.
As a regulated all-to-all FX options venue, CME provides a wide range of product and services in the FXO space. The FXO contracts are traded round the clock with market makers’ support to provide the prices. The most active FXO contracts are EUR/USD, JPY/USD, AUD/USD and GBP/USD and they are European styled options expiring at 10am NYC time. Upon exercise, they are physically deliverable into CME FX futures contracts which are also highly liquid.
Together with a broad spectrum of strikes available, FXO contracts maturities are listed to cater for both short term and longer-term trading strategies. For short term trading, CME has weekly FXO contracts that mature on Mondays, Wednesdays and Fridays which also serve as good instruments of those engaging in the gamma trading of their FXO portfolio. Longer term traders and traders that would like to trade the volatility per se can look at serial (monthly) and quarterly maturity FXO contracts.
FXO by maturity |
Suitability |
Possible economic and market events coverage/focus |
---|---|---|
Weekly
|
Short term FX trading strategies and/or gamma trading |
|
Serial - Monthly Quarterlies |
Longer term FX trading strategies and/or volatility trading |
Periods leading up to potential market moving events such as US elections, Brexit referendums |
Provided that existing screen pricing is inadequate, there is also a Request for Quote (RFQ) functionality. Point to note, though some dealing portals might have actual larger trading volumes going through, it might not be available to all participants in the market, resulting again in an uneven playing field.
I have personally traded both at institutional level and as a retail trader. Although everyone participates in the same global FX market eventually, the differences in trading perspectives cannot be understated. For a start, despite the opportunities available in the FX market, we do acknowledge that FX trading can potentially be highly leveraged. As with anything with leverage, it cuts both ways. As retail retails, we will not have access to the advanced risk management systems available to institutions or large corporates. The capacity to tolerate market swings is also usually lower. This is where retail traders could benefit from trading FXOs. One can choose to trade FXO strategies from the long side or use the flexibility of FXOs to structure one’s strategy to ensure that the downside is always limited. In this way, the maximum potential losses for the retail trader will be capped while he is still allowed to have a highly leveraged trading position.
Utilising certain types of FXO instead of outright FX cash positions also helps preserve our trading positions in times when the market is whippy, and where the FX cash positions are likely to be stopped out. Options also allow us to focus our trading themes across potential market moving events, for example key economic data releases, trade summits, central bank meeting announcements or elections.
Most retail traders are familiar with Contract for Difference (CFDs) marketed by various electronic platform providers. Unlike CFDs, CME FXOs offer transparent cost and equal access via a central limit order book that is cleared via a regulated clearing house. By trading through an exchange, retail traders get the same treatment as large institutions or corporates. With CME FXOs, your counterparty is the exchange itself, thereby eliminating any counterparty default risk.
One very useful tool to help us plan and manage our options strategies is the free online Quikstrike Calculator and Strategy Simulator. It allows us to structure our FX options strategies using current market prices and simulate the impact to our portfolio as the Greeks changes.
Thomas is the Founder and Managing Director of PZH Consultants. He is an accredited trainer in financial markets products, partnering with leading universities and financial institutions including CME Group, National Technological University of Singapore (NTU) and Singapore Management University (SMU). Thomas has over 20 years of experience in financial markets, notably in FX & interest rates derivatives products in the Emerging Markets space.