A fair bit has been made of the latest FX committee turnover surveys showing an increase in activity during a month in which people broadly experienced the opposite. Looking at the FX platform data and April was the worse month of the year thus far for everyone save 360T and Refinitiv non-spot products – and therein lies the reason, given 360T is still heavily reliant on non-spot business for its volumes.
There is no doubt that for those involved in the high volume spot business April was a pretty horrible month, but FX is about so much more than that (and I can’t believe, as an ex-spot trader, I have written those words!) as the FX committee data indicates.
I have written about the swaps data before, so I wanted to discuss another product line the growth in which raised a few eyebrows – FX options.
At face value it is a paradox that at a time when everyone is bemoaning the lack of volatility in exchange rates and limited opportunities to position, FX options trading goes up so strongly. In the UK FX options was up almost 15% from the previous April to $153 billion per day – it was actually slightly down from the October survey, however – while in the US it was up 18.7% to just over $52 billion per day. Across the other centres to report activity drops off quickly after that, but Singapore saw a drop of 10% to just over $30 billion, Tokyo was up around 10% at just under $10 billion and Canada and Australia were broadly unchanged around the $4 billion and $1.5 billion mark respectively.
These are pretty good numbers in the UK and US by historical standards, matching the highest levels seen since the highly volatile month of October 2014’s, so why are people paying premium when there’s nothing going on?
One answer could be that people are trading options for the sake of something to trade – and I have mentioned before in our In the FICC of It podcast that selling vol has become a popular (as well as dangerous and probably ill-fated) strategy in recent months, so it could be the short vol strategy has helped lift activity.
That still requires someone to be willing to buy of course, so maybe it is also the bargain hunters helping the numbers higher (in spite of most traders telling me vol continues to confound their expectations of what the bottom might be)?
I actually wonder if there is another factor in play that, somewhat like the turnover surveys themselves, gives lie to the story of FX markets being quiet? Could it be that people are not believing, or their experience in the market is radically different to, the hype? Looking at the options data from the UK and US what struck me was how the growth in volume was largely via the direct channels – in both centres, the Dealer Direct channel, widely seen as voice, drove about half of the increase, with the other half coming in different fashions. In the US it was the single dealer channel, in the UK, electronic broking systems and the multi-dealer channel.
This suggests customer trading to me, and indeed client segment volumes in FX options were up in both the UK and US, but it doesn’t solve the issue of why? I spoke to a couple of buy side firms, both of whom suggested that they were using options more to hedge because they were cheap. Historically both had used FX swaps and outrights to hedge, but over the last year they had switched to options because it gave greater protection as well as the opportunity to add revenue.
Of course, even if you spent $2k on an option in a market that never moved, you’d lose that $2k, so cheap is a relative term, there would have to be questions over the value of the trades. So while this may be part of the reason behind the strength I suspect the answer can be found in good old-fashioned market psychology – it’s too quiet. I have used the analogy before in these pages of the Hollywood western where one actor turns to another and comments how quiet it is seconds before all hell breaks loose, and I suspect for many customers in the market this analogy still works. Yes, markets are quiet and yes, vol keeps on driving lower, but they are probably thinking it takes one event to really spook the market and everyone will be looking at each other saying ‘why didn’t we buy protection when it was so cheap?’
It’s hard to know what that one event will be, this week we have had a couple of good shocks to the system, or indeed if the death of low vol will be via a thousand cuts, but prudence would probably dictate that in the current geo-political and indeed macroeconomic environment, having some hedges and protection in place is the right thing to do. So we can analyse and surmise, but at the end of the day I suspect people are trading options because they don’t, to use another analogy, want to be caught with their pants down when things go pear-shaped, They also, most definitely, do not want to be the one to explain to the board why they were so horribly caught out.