FOREX: Options and New Clearing House Rules
The Commodity Futures Trading Commission guidelines are part of the mandatory regulation of foreign exchange derivatives, which are predominantly used by banks and other institutions.
With the growing debate on how to best create and execute a viable clearing system, Forex options trading has had a huge surge of growth and popularity. ETFs based on currencies are being introduced as well as an alternative to trading Forex and unforeseen problems with a new clearinghouse.
Last year the new Swap Executive Facilities SEF emerged mid-year with immediate disagreements and disorganization in several areas, as institutions struggled to choose from a large group of SEFs and understand the regulations in order to properly comply.
The problems with the various new SEF regulations, what types of products and package trades had to be cleared, and the conflict of whether the derivative product was required to be executed on a futures exchange or the SEF led to plenty of disgruntled and confused traders and institutions.
An overall decline in activity ensued and the overall swap derivatives market saw a drop in activity, as institutions sought out alternative trading instruments and products that had no conflicting regulatory elements.
With Forex facing a similar scenario this year many institutions are already moving to alternative trading instruments and products, to avoid the problems Forex will face as it moves through the clearinghouse regulatory process. It is expected that this process will be far more complicated, more confusing, with far more disagreement than the IRS and CDS regulatory clearinghouse shift.
Institutions are moving to several different types of instruments that are still based on foreign exchange instruments but traded on already established exchanges, thereby alleviating the risk of the complications of new regulations and new clearinghouse difficulties.
Here is what the institutions are starting to trade as an alternative:
Forex Options are very popular as this is a straight-forward exchange traded Forex derivative with simple calls and puts, which are very similar to a stock option call or put. The difference is that the Forex option transaction is buying a call or buying a put as a Forex trader would in the regular Forex market. SPOTs or Single Payment Options Trading are also available, and becoming more popular for many different institutions for various portfolio purposes.
Forex Options are gaining in popularity as they are relatively easy to learn to trade. These types of options for the foreign exchange trader and the over-the-counter transaction process are already clearly defined and operational whereas the new Forex clearing houses are brand new and untested, lacking a complete system process, and fraught with argumentative debate as to how they should be set up.
Meanwhile the institutions need a method of trading Forex that has lower risk with good upside potential. Forex Options are an obvious fit that eliminates many problems and requires minimal time to trade.
The other instrument that many institutions are considering is the Forex ETF traded on the stock exchanges. These are traded just like stocks but are based on a Forex pairing. The orders are simple and chart analysis is available to track the ETF and the trade.
Here is what this means for the retail Forex trader:
Forex is a market that is massive and highly complex with several levels of access. Retail Forex traders are on the outside with limited access to the real Forex market. Retail Forex traders are trading against their brokers rather than in the general Forex market. The impact that will be felt is from the broker fills for Forex Retail Traders. Many brokers will be required to meet the new regulations for Forex trading and clearinghouse rules.
The disruption of the Forex market from confusion, changes to structure, defining parameters of what must be cleared, how this will change the business models for institutions, and how long it will take to fully integrate the new regulations and clearinghouse rules are factors that retail traders must not ignore. While on the surface things may seem the same, the underlying hidden activity that retail traders do not see may cause problems for retail that they are not expecting.
Forex trading may become more volatile. Certainly Forex options and ETFs based on foreign exchange pairs will increase with more and more activity in these two exchange platforms.
All retail Forex traders should do as the institutions are doing which is to check out alternative instruments to trade Forex, such as Forex Options or ETFs based on pairs. With the lower risk aspects of Options trading, many Forex traders may find that their profitability rises as their risk drops.
Options Forex trading is a solution for the institutions at a time when the Forex market is facing massive disruptive changes. Retail Forex traders need to also investigate all of the different ways they can trade Forex.