FX Link: Optimizing an Exchange-Listed FX Option Hedge

FX Link is a CME Globex-traded spread between FX futures and OTC Spot FX. FX Link is traded as a differential between FX futures and Spot FX. The spread results in the simultaneous execution of FX futures cleared by CME Group and OTC Spot FX subject to OTC documentation and credit relationships.

Let’s look at a market scenario of how FX Link could be used to optimize an exchange-listed FX option hedge.

Assume a fixed income portfolio manager has a euro-denominated bond maturing and wants the proceeds repatriated to US dollars for use in the United States. A typical OTC market approach might be purchasing a EUR/USD put option with a custom expiration date. If the put is in-the-money at expiry, the portfolio manager would exercise the option, automatically delivering into a short EUR/USD spot transaction that would serve to move the bond’s proceeds from euros to US dollars.

If the put is out-of-the-money, the portfolio manager will need to sell euros for US dollars in the OTC spot FX market. The reduced transparency when trading bespoke options usually results in high execution cost and can lead to significant price slippage if the portfolio manager chooses to offset their option position prior to expiry.

Alternatively, the portfolio manager can buy an exchange-listed EUR/USD put option at CME Group, anonymously, with the benefits of transparent, competitive central-limit-order-book pricing.  If the put is in-the-money at expiry, the listed option is auto-exercised. The portfolio manager can then buy the EUR/USD basis on FX Link to offset the short futures position originating from the options’ exercise while achieving the desired spot settlement of selling euro for US dollar.

If the put expires out-of-the-money, the portfolio manager merely executes a spot transaction instead, selling euro for US dollar.

By using listed, CME Group options optimized with CME FX Link, the portfolio manager can repatriate euros to dollars while benefiting from the transparency and efficiency of the world’s largest FX options central-limit-order-book, the benefits of central clearing, and the capital efficiency and funding benefits of futures and options portfolio netting and margin optimization.

This is just one example of using FX Link to manage risk and positions across OTC FX spot and CME Group FX futures, seamlessly connecting the two markets and allowing you to better manage and optimize margin and credit lines.