Every treasurer knows what FX options are – but not necessarily how to use them to maximum effect. This article examines the challenges hedgers face when using options, including costs, and outlines the optimisation opportunities that can be harnessed by moving away from conventional buy-and-hold FX strategies.
The FX market remains the largest market in the world. According to the Bank for International Settlements’ (BIS’) most recent triennial report (published in 2022), average daily volume in the market across all products is pegged at $7.5tr.. Of that gargantuan amount, FX options may represent a small slice at $300bn, but that still makes the FX options market the largest options market by far. For comparison, equity options in the US trade, on average, a daily dollar volume of $20bn.
Even in the fixed-income markets, the best estimate of global daily volumes for options runs to $40bn across all currencies. The takeaway is that despite options representing just 4% of total FX volumes, the absolute amount of activity is large and liquidity available, at least in the major currencies, is typically quite deep.
With that as a backdrop, the question at hand is how best for hedgers to utilise FX options as part of their hedging programmes. The most frequent complaint about options from a hedger’s perspective is their cost. This relatively high cost stems from the fact that there is an opportunity available for option owners during the life of the option that does not exist in the FX forward space.