Taking the Controversy Out of the FX Options Cut

Whether it be hedging activity, traders using information or just happenstance, a persistent challenge and area of controversy in FX markets for decades has been options cuts. Spot markets often gyrate towards large expiries and the establishment of the actual price at the various cut off times is often swathed in uncertainty and opaqueness.

This is not just a problem for buyers of the options, the writers have significant “Pin” risk, where they simply don’t know whether the option will be exercised or not and therefore could have significant market risk.

To meet this challenge, New Change FX (NCFX) is rolling out an existing product at scale to help both sides of the trade better manage the associated risks. The NCFX Currency Options Cut is a service the firm has been providing to LCH for some time according to CEO Paul Lambert, but one that it now wants to deliver to the broader industry. “Following the completion of our migration to the cloud, we have been more proactive about this service, and have started attracting strong interest from banks and other firms’ options trading desks,” he says. “By enabling both sides to monitor the spot going into the cut, and then deliver the actual rate, we are helping to automate what has been a very manual, and operationally-speaking, risky, element of the business.”

The firm has completed a pilot with FX options trading platforms Digital Vega and SpectrAxe. Essentially the service publishes live official benchmark prices to determine the actual cut. “By simultaneously providing both sides with the expiry price, we are taking the uncertainty, and potential for dispute over whether the option was in- or out-of-the-money at expiry, out,” explains Lambert. “Mitigating Pin risk means writers can hedge their open position with more confidence and automate the expiry process through to clearing and settlement.”

NCFX is offering the service every business day for 84 contracts and the cuts in Tokyo (3pm), Warsaw (11am), Budapest (noon), London (noon), and New York at both 10am and 12.30pm are covered. The firm says it plans to add more currency pairs, such as ILS and precious metals.

The product is available real-time over multiple connection protocols to feed different parts of subscriber operations. For the lowest latency, the live options cut price is available in a machine-readable format via FIX API or WebSocket connection that can be established via Cross-Connect or through the public internet. NCFX says this feed can power expiry software directly, thereby removing the need for human intervention. The cut rates can also be made available on demand to call in RESTful API, Graph API (as of 2023) or as a call through the NCFX SFTP server.

“Our strategy is to work out what problems need to be solved in the FX industry and provide a solution,” says Lambert. “There were clear risks involved with the expiry of FX options and thanks to the work of the past year we are now able to scale our solution and provide all parties to the trade with certainty through a regulated and independent benchmark.

“There is a wider challenge in the FX industry around the use of bad data in making decisions,” he continues. “This is one way in which we are helping improve the decision making process.”