In 1972, the Chicago Mercantile Exchange began trading currency futures, which allowed financial institutions, corporations and individuals to manage the risk of foreign currency value fluctuation. In 1982, options on currency futures began trading on exchanges. This was a great benefit since it allowed a smaller investor to trade on the currency market without the size investment and delivery risk associated with the futures markets.
The major benefit to exchange-traded currency options is the use of a standardized contract across all exchanges. Trades are settled through the clearinghouses associated with the exchanges, which guarantee against default by either party to the trade. All this is important because a rapid, freely trading market requires a trustworthy framework in which to develop. Standardization of documents means there are no hidden surprises in any trade, and if you buy an option on euros, you may rely on it being deliverable.
Unlike futures contracts, which are actual contracts to receive and deliver a specified amount of currency, the purchasers of exchange-traded currency options need not worry about being forced to receive or deliver large amounts of currencies if they forget to close out their contracts in time or are unable to do so. A trader may buy puts and calls on a currency without ever owning the underlying futures position or the currency itself. These options are written (created) by traders who have purchased or sold futures contracts or own the currency. If you write an option on a currency, you have full financial liability to receive or deliver the currency.
Exchange-traded options are growing in popularity because in a global financial marketplace where credit ratings and geopolitics change quickly, the exchange acts as a central counterparty to each transaction. It ensures complete transparency and provides standard processes and procedures as well as financial safeguards that are not found in private over-the-counter transactions between individual traders, who may represent creditworthy institutional trading desks or small-time risk takers.
In the United States, the Securities and Exchange Commission regulates currency options traded on securities exchanges such as the NASDAQ OMX PHLX — the combination of the Nasdaq; the OMX (established as the result of the merger between the Swedish futures and stock exchange, OM AB, and the Helsinki Stock Exchange, HEX); and the Philadelphia Exchange, or PHLX. The Commodity Futures Trading Commission regulates those options traded on commodities exchanges such as the Chicago Mercantile Exchange, or CME.
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