Monday, July 29, 2013

sell-side on the FX Vol market

Backgrounder -- The traditional meaning of a "sell-side" is basically a player who makes a living
- by commission or
- by earning bid-ask spread (market makers),
- but no insurance premium.
Such a player provides liquidity to the market and seldom consumers liquidity. In so doing they provide a valuable service to the market and are rewarded. In a sense, they sell liquidity.

I now think of fx options as even more like insurance than equity options. There's economic need for fx options. Demand comes from mostly (MNC) corporations. They buy this insurance because they need protection.

Since fx options are insurance, it's natural to classify the participants as sellers and buyers. I guess some big players in this market stay primarily on one side only. (Some banks may need to pay insurance premium just for hedging.) If that's true then the "sell-side" concept can be adjusted to mean players who make a living selling insurance who seldom buys the same insurance except for hedging.

The mainstream sellers are banks. If the interbank bid-ask vol spread is narrow, then these sellers will have little restraint from frequent buying/selling.

Compared to corporations, is there an even bigger category of buyers in the fxo market? I don't think so. I have no statistics, but I believe corporations are the most stable client base for the banks.

I think the commodity options (or options on futures) market isn't that active, but these option sellers are, likewise, insurers to provide for an economic need.

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http://www.linkedin.com/in/tanbin