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Vanilla Currency Options

Now let’s look at some of the larger exchanges where vanilla currency options are traded and details of how the ‘products’ are operated by the exchange. As you will see, currency options are very similar to other types of option such as an equity option. Both have strike prices, expiry dates, and premiums, and can be bought and sold as the value is affected by changes in the underlying asset. As with all options, time is a wasting asset, and both have intrinsic and extrinsic value when in, or out, of the money. The biggest difference however is in the size of some of these contracts where trade sizes can be a minimum of 100, along with the fact that most currency options trade under the European style. Lets take a look at five of the major exchanges for currency options trading.

Liffe started life as the London International Financial Futures and Options exchange, but in a series of takeovers and mergers, gradually moved from Liffe to the more European based Euronext Liffe, and finally to today’s position, where it has been acquired by the NYSE, New York Stock Exchange, and is now known as NYSE Euronext. This exchange currently only offers two currency options, the Euro/Dollar and the Dollar/Euro. Both of these options are European style with the ticker DEX, and are traded through the Amsterdam exchange ( AMS). The unit of trading is 100, with a contract size of 10,000 USD, so these are large contracts and not designed for the small retail investor! A variety of option contracts are available from 1,2 and 3 months, with quarterly expiry on the third Friday of the month, provided this is a business day. As these are European style,  holders of long positions are not allowed to exercise before the exercise date. These products are designed for inter bank speculative trading and for international companies to hedge risk on future currency movements. As with other types of option, if you want to find the broadest markets with the greatest volume, the best places to look are the American Exchanges.

The Philadelphia Stock Exchange is perhaps the most interesting of all the exchanges worldwide, although not the largest,  as they have recently introduced a range of currency options, aimed at the smaller retail investor. These are called the PHLX World Currency Options, and are the first of many products which I believe will eventually offer a more secure and regulated environment in which to trade currency options. The exchange currently provides options on the following currencies – Australian Dollar, Canadian Dollar, British Pound, Euro, Yen and Swiss Franc, and all are settled against the US dollar. The contract size is 10,000 with a minimum trade size of 1, so they are equivalent to contract and lot sizes in the retail ( off exchange ) markets. As with the Euronext options, these are European style so cannot be exercised until the last day of trading, but they can of course be bought and sold prior to expiry. Now, for those of you used to trading options, these will be very familiar. All the information is provided in an option chain for puts and calls, with open interest volumes, strike prices, premiums and choices of expiry periods. Both monthly and quarterly contracts are available. Remember that all these options are settled against the US dollar, so if you bought a call option, you would be forecasting that the foreign currency would strengthen against the dollar during the life of the option contract. For put options, you are forecasting that the foreign currency will weaken during the contract period.

The Chicago Board Options Exchange is the largest options exchange in the USA and is probably one of the best sites for free information, help and education, and is worth a visit even if you are not proposing to trade currency options, but other option types. The site has recently introduced a paper trading and virtual trading platform which provides you with the opportunity to become comfortable with reading option chains,  opening and closing positions, and testing strategies.

The Chicago Mercantile Exchange  currently provides a range of currency options on the following pairs, all based against the US dollar – these are the Swiss Franc, the Japanese Yen, the Canadian Dollar and the Euro. Now one thing you need to be careful of is that these contracts are offered in both European and American style, so please check. As with the Philadelphia Exchange the contract size is 10,000 and the minimum trade size is one, so again you can trade these as a retail investor in small quantities. Monthly and quarterly contracts are available with contracts expiring on the second Friday, immediately preceding the third Wednesday of the contract month.

The final exchange is the  International Securities Exchange which some say is actually larger than the CBOE. The ISE operates a wholly electronic trading platform, and is based in New York. This exchange currently only offers four currencies, namely the British Pound, the Euro, the Canadian dollar and the Japanese Yen. All options are European style. The ISE exchange is in fact not an exchange at all, but an electronic auction of options which was one of the first to replace the floor based trading systems, widely used in the late 1990’s and early 2000.

In summary, these are just a few of the larger exchanges that list currency options – there are many more around the world in the Far East and Australasia, but all have several things in common. Firstly, the markets are generally limited to the major pairs only, and do not include the cross pairs, although this is likely to change as the market develops. Secondly, to trade these options you will need to have a specialist broker – your regular forex ‘broker’ will generally not offer this as a service for you.  Finally an options broker will not accept you as a client to trade options, unless you have some previous trading experience, as these are specialist and sophisticated instruments.