FX Link: Replacement of OTC FX Option Delta Hedge

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

Example

Here is a market scenario of how FX Link could be used to replace an OTC spot FX delta hedge of an exchange-listed FX option transaction for enhanced margin management.

Assume a bank sells at-the-money put options on the EUR/USD futures contract.

The bank wants to delta hedge the short at-the-money put options against price movements in the underlying futures contract to create a delta-neutral position that will profit from lower implied volatility or time decay.

The bank has easy access to the OTC spot market and chooses to sell OTC spot FX in an amount equal to the delta hedge. This creates a delta-neutral portfolio but introduces basis risk from the difference between spot FX and the option’s underlying futures contract forward points. It also creates additional margin costs, given one exposure is OTC and the offsetting exposure is on exchange.

However, the bank can use FX Link to replace the OTC spot FX delta hedge with the equivalent futures position in one easy transaction. The bank would sell the EUR/USD FX Link spread, simultaneously selling EUR/USD futures and buying EUR/USD spot FX in the delta hedge amount.

By using this approach, the banker effectively replaces the OTC EUR/USD spot position with a delta equivalent IMM-dated EUR/USD futures position that receives the full benefits of central clearing and portfolio netting of futures and options for lower funding requirements.

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