Kris, the ISE is the world’s largest equity options exchange. Why did it decide to offer FX products?
We thought the time was right to diversify ISE’s product suite to include a new asset class. We targeted FX specifically because of the increasingly active participation among individual investors in the FX market, and because we could provide the same efficiencies and advancements we had previously introduced to the equity and index options market. Additionally, our brokers had indicated that customer requests for an FX product were becoming more frequent. Equity options continues to be our core business, but we are continually evaluating opportunities to expand outward from that core, and developing an FX product met that criteria.
You are responsible for all phases in the development of innovative tradable products from concept to commercial launch. How difficult was it for the exchange to gear up and put in place the required technology and infrastructure to trade currency products?
Our platform has been designed to be very flexible and scalable, which made it relatively easy to add FX options. From a technology point of view, not only can we offer options on almost any underlying asset class or measure, but we can accommodate the trading and quoting activity of new participants on ISE. Additionally, the product was designed to leverage the infrastructure already in place with market makers, brokers and the Options Clearing Corporation (OCC).
What do you consider to be the main attractions of using exchange traded FX products?
ISE introduced a number of features into the FX market that are taken for granted in the equity and index options market today. Exchange functionality and central clearing are two main attractions.
FX Options take advantage of functionality ISE developed for the equity and index options markets, such as spreads. For the first time, FX traders and investors can employ strategies like straddles, strangles, and butterflies in a highly automated way.
Regarding central clearing, unlike traditional OTC FX options, ISE’s product is cleared by the OCC, thereby mitigating the counterparty credit risk that weighs on the participants in the OTC market.
The ISE reported average daily trading volume of 7,600 FX options contracts for April 2008. This was up 193% on April 2007 figures, the inaugural month of FX options on the exchange. Were you anticipating this level of interest and growth in such a short time?
We were very pleased with the quick ramp-up in trading volume. However, we recognize that there is still a long way to go in terms of education and awareness, and we will continue to focus our efforts to take this product to the next level.
What factors do you believe are mainly responsible for the increased volume of trading?
Product design and product distribution helped speed up the adoption rate among traders and investors. FX Options are cash-settled, which means no one has to make or take delivery of multiple currencies. This dramatically simplifies the payoff, streamlines the clearing process, and ultimately makes the product cheaper to trade. FX Options also have underlying values that track the prevailing rate for each currency pair. This provides investors with an indication of spot market prices, but also allows them to take advantage of broker functionality, such as contingent orders.
Product distribution was also a major factor because FX Options are securities that can be traded in the same accounts of broker-dealers that trade equity and index options. Existing accounts with access to the options markets had immediate access to FX Options.
Lastly, ISE’s market makers were able to leverage their existing technology developed for quoting equity and index options. Since their systems were also scalable, an exchange-listed product allowed them to expand into a new asset class while not taking on significant development costs.
The ISE has introduced a new membership structure specifically for FX? Why was that done?
ISE established two new market maker classes as a way to increase competition in the product. The framework allows firms that may be new to ISE, but established in the FX market, to become market maker members at a very low cost. We believe that diversification among liquidity providers will have an immediate impact on market quality and ultimately benefit investors and traders.
What efforts are you making to attract new players that will convince OTC participants to trade exchange-listed FX products?
Our overall goal in creating an FX Options marketplace was to provide an intuitive product for retail investors to act on their views of the US dollar. However, it quickly became evident that we had a much larger opportunity to democratize this area of the FX market by allowing traders of all types and sizes to participate on an equal footing. In recent weeks, we have heard from several institutional investors, inter-dealer brokers, and other traditional participants of the FX market. To encourage greater participation from this segment of the industry, we are evaluating ways to make our fee structure more attractive for larger size trades.
In recent years the securities exchanges have built up very sophisticated infrastructures and distribution networks to support traditional equity option trading. In what ways is the ISE leveraging its existing options trading technology to deliver new trading functionalities to the FX market?
Product distribution and exchange functionality are such important points to make that they are worth reiterating. Our FX Options are available to every trader that has access to US options markets. Customers of online brokers and full service brokers can trade the product today as long as their accounts have permission to trade equity or index options. In general, all firms connected to ISE directly, or indirectly through a vendor or order-routing firm, have access to FX Options.
Complex orders are also a major breakthrough that ISE has brought to the FX industry. Traders can automatically execute spread strategies up to four legs as one trade. This is unique functionality in the FX space.
Market makers in equity and index options have very complex quoting engines that were developed over many years. Are you confident that FX market makers will easily be able to adapt to the high speed trading and particular features of ISE?
ISE recognizes that FX firms with little experience quoting equity or index options on an electronic exchange will have technology development requirements. However, the spot FX market is also electronic and we expect that the depth of expertise developed there will translate well into building the quoting engines necessary for FX options. The two primary areas that the new firms will need to address are the rapid rate of quote changes and integrating the functionality that ISE offers which is not currently available in the FX spot market.
Decimalisation has already been cited by many as a key driver in the use of algorithmic trading in equities. If the options industry were to move to a penny environment, do you believe this could lead to greater use of algorithmic trading strategies in equities, index and FX options?
We are already there. FX Options are traded in pennies and we are speaking with algorithmic trading firms as well as brokers that offer such trading services for equity and index options. Considering that those firms are already connected to ISE, FX Options provides them with another asset class to trade or to offer their customers with very little start-up work required. FX Options also offers the opportunity for such firms to expand their target market to include potential FX customers.
Do you believe FX options will follow the same path as equity options, which was originally a retail-orientated market but which succeeded in attracting the bigger players once there was proven liquidity?
I believe that FX options will follow a similar trajectory. As liquidity continues to grow in our FX Options market, institutional participants will find that they can execute in size and benefit from the advantages of the listed market. It makes sense for those firms to get involved early on, albeit slowly, rather than have to catch up.
The major six currency pairs are currently traded on ISE? What plans do you to expand the FX product line?
We have the regulatory approval to list 19 USD-based pairs and up to 47 cross-rates. We think that effectively covers most of the existing activity in the space, but stay tuned for new innovative FX products from ISE.