The Last Look…

Market structure evolution is a regular theme in these pages, and indeed this column, and most often it is targeted at the spot, and occasionally swap, markets – but what about FX options? Over the past couple of years this space has seen increased competition through new platforms, how is it likely to play out?

One thing seems clear to me is that there is still all to play for in FX options when it comes to the multi-participant space, (the banks have ensured they have kept their technology offerings up-to-date, or at least still workable in some cases) new platforms have launched but the sense is all are still milling around looking for an opportunity to make a splash. This is reflected in the recent data from the UK and US FX committees, which highlighted just how stable execution channels are in FX options.

In the UK, there was a small uptick in the Customer Direct channel (to 37.5%, making it the busiest channel for options), electronic broking also ticked higher, by about 1%, both came at the expense of the voice brokers. In the US, ECNs saw a small uptick, to 20% from around 17.5% in recent years, and this came largely at the expense of Voice Direct channel. Otherwise, the percentage of volume grabbed by each channel was largely unchanged.

A couple of caveats around this data. The UK and US committees report execution data in slightly different formats, and a couple of reports ago, the UK for some reason stopped differentiating between single and multi-dealer channels, which is a shame – perhaps someone didn’t like the way the numbers were trending! There are also occasional outliers in the data, for example, in the US report for October 2024 there was a large spike in Voice Indirect (via brokers largely), at the expense of Voice Direct, as well as in the Other category (this is mainly MDPs at aggregators). Both reverted to long-term levels in the latest report.

So, how will things play out from here? There is clearly plenty of interest in FX options – global turnover levels are more than double what they were in 2021, and last month CME Group put out a report highlighting H1 growth of around 65% in FX options average daily volumes on the exchange compared to 2023 and 2024 data. Equally, but anecdotally, banks in particular are talking about a surge in interest from clients thanks to the current volatility.

So the interest is there, how will it play out and will the industry, collectively, take any lessons from the spot market. Fragmentation in options is a given, thanks to the opportunity, but I suspect it can only go so far, the absolute volume numbers are not there to support endless fragmentation. Equally, non-bank market makers are playing a bigger role, but as is the case in spot, they seem largely limited to venues where other dealers can clear risk, rather than attracting end-client business.

So far, so similar then, but I suspect things will diverge from here. Is there, for example, real demand for a CLOB-like structure(s), to assist price discovery? If we pare the FX market back to its core, the focus is on end-clients, and they have very different needs when it comes to options, even on a trade-by-trade basis – this makes a CLOB a difficult environment in which to operate. Their risk is often quite sizeable, which also has implications for the liquidity providers – talking to a couple of buy side firms that have increased their options trading recently, they were keen to stress how their options business remained upon what is very much a bilateral basis, as they were well aware of how tricky it has become for LPs in other markets dealing through certain channels, which has resulted in a widening of spreads.

Regulations will, inevitably, have a role to play in this market, but until, for example, the cost of clearing does become manageable for both sides, OTC is going to remain the dominant platform, meaning non-bank firms will find it harder to connect in to the genuine buy-side. CME will remain a major player, and its agreement with Digital Vega also means it has a foot in the OTC camp if required (and vice versa of course), but it is hard to see an environment in which it dominates – unless there is a massive change of heart on the part of a large number of buy side firms.

Things could be more even interesting in the B2C world, where a slightly different attitude to execution protocols, coupled with a shared desire to keep things as quiet as possible, could mean a new model emerging

This makes the OTC space really interesting. The bilateral, RFQ model will likely remain the dominant feature in options, although one lesson from the spot market may have an influence – rising brokerage costs. I have had more conversations with buy side firms about the cost to their LPs of doing business on the multi-dealer platforms than I have probably ever – it is something of which they are keenly aware. This means any of the technology firms pushing for a significant piece of the options market will need to price accordingly – I can’t see how the LPs in particular will stand another market in which the brokerage is more than the spread charged (but then competition does funny things!)

So price point is important, and so too is the trading environment. Another feature of my conversations in recent months has been how to avoid market impact in products like options, where the cost can become significant. It is interesting to hear more people talk about a dark environment for their business, one where market data is harder to come by – does this signal a change in attitude? No-one seems to care in EUR/USD one month 25 deltas, but you don’t have to move far from there to enter a world where executing or managing even modest risk becomes a trickier proposition.

In the short-term the status quo is likely to persist, but as more recent platforms start to build some traction (assuming they can of course, that is not a given in this world) then choice will emerge – as will potential winners.

There will always be a role for a platform on which active traders can punt around, nick a point or two here and there, and generally have fun. More pertinent, however, is that B2C world, where a slightly different attitude to execution protocols, coupled with a shared desire to keep things as quiet as possible, could mean a new model emerging.

If this happens, it is unlikely the spot world will pay any attention – the NDF market is widely seen as much “cleaner” for all participants thanks to market structure nuances, but spot didn’t take any lessons from it – but it should. I sense a changing mood on both buy and sell-side. This may manifest itself in a good market structure for FX options, I wonder if, down the road, it permeates spot as well?

colin@thefullfx.com