Optiver aims to gatecrash FX options private party

Dutch non-bank hopes to exploit shift to electronic markets in OTC options, following record $7bn trading day

In the weeks following Russia’s invasion of Ukraine, traders began to notice big movements in the foreign exchange options market. A flurry of downside bets on the euro/US dollar resulted in wild price swings, sparking concerns of a liquidity squeeze on one of the most heavily traded contracts in the world.

Real money clients like pension funds and non-financial corporations, as well as hedge funds, were frantically calling their market-makers to hedge their exposures to any Russia-related sanctions. It was during this period that Optiver, the Dutch high-frequency trading firm, saw a surge in activity.

On March 4, the firm recorded its highest daily notional traded in FX products of approximately $7 billion.

“We saw FX options prices become far more volatile. The flow in the market was also very one-directional, making liquidity provision difficult, and leading to some dislocations there,” says John Rothstein, CEO of Optiver UK, its FX market-making business.

Rothstein believes the upheaval in the market showed the worth of non-bank liquidity providers – like Optiver – which can warehouse risk from banks and counterparties in times of turbulence.

“Not only does it reinforce the need for more alternative liquidity providers, but also the importance of end-users being able to easily access the pricing of more liquidity providers, both alternative and standard. We don’t rely on immediately offloading the risk we take on the market – we’re happy to inventory it for a while or hedge it with less correlated products – so the lack of liquidity doesn’t hamper our ability to make markets.”

Point of difference

While Optiver has been a market-maker in equities and listed derivatives for some time, gaining a foothold in the FX options market has been a struggle, the firm admits. The market has high barriers to entry, with trades mostly executed bilaterally, handled by the few incumbent banks that have the balance sheet and risk appetite to deal in highly specific and complex instruments.

Optiver moved into the FX options scene in 2017 with a simple pitch: to offer its own liquidity as a complement to the larger banks, giving them an alternative to warehouse their risk and specialising in short-term options trades.

It started by trading bilaterally with the banks, and then from 2019 used interdealer brokers such as BGC, Tradition and TP Icap.

Rothstein explains that Optiver has developed its use of short-term options and so-called event pricing as a “competitive advantage”. “Short-term options are really in Optiver’s DNA,” he says.

The firm’s experience in short-term pricing means it is “comfortable” trading options with high gamma, Rothstein says. Gamma is a second order derivative that represents the option’s sensitivity to the rate of change of the underlying security’s value.

In the listed space, access to credit and financing is more available. The OTC space is less democratised

John Rothstein, Optiver UK

As the FX options market shifts towards electronification, opportunities are opening up for non-bank trading firms. In November 2020, Optiver began trading on Refinitiv’s FXall, becoming the platform’s first non-bank liquidity provider for FX options, initially with banks and then from April 2021 with the buy side. One year on, Optiver is branching out to BGC’s Fenics and is also in discussions to go live on Digital Vega’s new Clob, or central limit order book. The firm is also looking to expand its product set to include Scandi currencies, Russian ruble and South African rand, crossed with the euro.

But FX options is a fragmented market, with trading split by execution type: chat, voice, single-dealer, multi-dealer. This splintering of activity means that Optiver has to be flexible otherwise it risks losing out on business.

“If they [counterparties] want to trade by phone and on a pure bilateral basis, we will do that,” says Rothstein. “The reality of the FX options market at the moment is that it’s not really an all-to-all market yet, with still a fair bit of fragmentation.”

Being able to warehouse risk and provide automated pricing has required the firm to invest in technology. Optiver has had to build a platform that can cope with a decentralised market structure so it can funnel information from multiple sources into a single pricing engine. Here, the firm aims to apply some of the attributes of the listed futures market – automation and efficiency – to the OTC market.

The alternative liquidity provider has also had to work on its risk management function to handle this kind of activity. Optiver’s risk team is able to access the same information as its traders alongside data from other sources, and has its own set of position information that’s downloaded independently. The company says this allows the team to shape their options risk framework to account for Greeks, gap risks, scenario risks, capital usage and credit risks.

Closed shop

There’s a reason why upstarts like Optiver have found it hard to break the oligarchy of the over-the-counter FX options market. Large banks are the main market-makers. Those same firms also act as gatekeepers for credit and financing, so it’s easier for them to snuff out competition that they deem a threat.

“In the listed space, access to credit and financing is more available. The OTC space is less democratised,” Rothstein says. “For that reason, it’s taken a lot longer for there to be alternative liquidity because it has to get to a point where the banks feel that it would be additive to themselves.”

Regulatory capital requirements have also given non-bank liquidity providers an edge to exploit. The Basel III capital regime has made it more expensive for large banks to be active in all segments of the market, while clients can have specific demands that only certain providers can meet.

As a non-bank not subject to the same capital requirements, this is where Optiver feels that its liquidity can be complementary to the incumbents. “For banks that take customer flow, often it’s too big for what they are willing to keep on their balance sheet. This gives us an opportunity to warehouse this risk for them,” says Rothstein.

While most FX options are still executed by voice or Bloomberg chat, the liquidity provider is gearing up for the electronification of the market. Since Optiver began executing interdealer trades on FXall, its counterparties have grown to include systematic hedge funds and proprietary trading firms that require fast, tight pricing and are familiar with electronic execution on multi-dealer platforms.

“There are more systematic end-users that want to trade FX options with liquidity providers that can stream quotes quickly and in real-time. Once we get that demand, then it becomes an issue of setting up connectivity with the platforms, getting access to credit, navigating the back end and all the things that are unique to the OTC market,” Rothstein says.

Digital Vega is one platform that is betting on the move to electronic, with its newly launched interdealer Clob for FX options. BGC spin-off Fenics Direct, meanwhile, is mulling a launch of its own. Rothstein hopes the arrival of more multi-dealer platforms will help help improve liquidity by giving voice to a wider range of liquidity providers.

Furthermore, some believe the next phase of non-cleared margin rules will encourage more buy-side firms to adopt central clearing for FX options and forwards. Rothstein believes any move towards clearing would also have an effect on electronification.

“Cleared FX options would go a long way to democratising credit, standardising the back-end processing, and will push us more towards lit Clobs. A cleared product is not the same thing as electronification, but they very much go hand in hand. For us, we think the biggest way to make this market accelerate along that journey is by introducing clearing, whether it’s by regulatory mandates or market demand,” he adds.

As Optiver pushes its OTC business, the firm is also looking to attract flow to the listed FX options market, where it is the number one market-maker on CME.

During recent weeks, market participants have reported huge dislocations not just in euro/US dollar OTC options but also in other euro currency pairings, including euro/Swiss franc and euro/yen. As a result, demand from dealers, agency brokers and other non-bank trading counterparties has shifted to the listed space, Rothstein says.

“Because of the dislocations in the market, parties were seeking out liquidity in the listed space, where there were continuous, streaming, dealable prices,” he adds.

To further grease the move from OTC to listed, Rothstein believes the exchanges should work harder to bring down their prices.

“It’s incumbent on the exchanges to make their pricing as simple and competitive as possible to attract that bilateral flow on to the exchange. Competitive pricing from the exchange-traded derivatives side is one way to bring more of that flow to the listed side because the total cost of doing business is important to all firms,” he says.

Editing by Alex Krohn

Update, 29/03/2022: This article was amended to show that Optiver trades on a counterparty-by-counterparty basis only.