Digital Vega Benchmark Expiry Automation

Over the last 3-5 years, electronification and automation of FX Option trading has grown significantly and will continue to do so for the foreseeable future. In some cases the trade lifecycle is now virtually fully automated; from order inception, import, execution, confirmation and reporting. Where the current process fails is around expiry management; this remains hugely fragmented, manual and increasingly prone to operational risk.

Using electronic trading channels has allowed active users to manage smaller exposures more efficiently as they can now execute many more smaller transactions to better manage their risks. DV has already witnessed significant growth of smaller, more customised transactions over the Medusa platform.

In the absence of any form of automated exercise management solution however, increasing transaction volumes will automatically generate much greater levels of operational risk, creating a major bottleneck and a potential barrier to further adoption.

For many years, the active trading community has been ambivalent on any form of automation but against a background of more stringent regulation, increasing costs and growing operational risks, attitudes are now starting to change and there is increasing anecdotal evidence that an automated solution would gain support across the market

 Listed Market Precedent

Active Futures Markets such as CME and Eurex already operate automated expiry systems which have been widely used for many years. More recently, LCH is in the process of launching a clearing service for OTC FX options which will initially be used by the major FX banks and will subsequently be offered to active buy side accounts. This service also incorporates an automated FX option expiry management solution using an industry and regulator approved benchmark rate provided by New Change FX in London.

Digital Vega Automated Exercise and Expiry Management

In parallel with LCH, Digital Vega, in partnership with New Change FX, will launch an automated exercise and expiry service. 

Digital Vega’s “Cut rates” will be determined using the independent New Change Benchmark FX rates that are approved by the FCA and ESMA and which are already being used by LCH in London to manage their cleared FX Option flow. Using common “Cut Rates” provided by a robust and independent pricing source across both cleared (LCH) and non-cleared D2C channels will significantly reduce operational (Pin) risk for major participants active in both markets. The same rate source and logic will also be used to provide Benchmark “Cut Rates” for currency pairs not currently delivered by LCH.

At start of day, on date of expiry, a list of all relevant expiring options will be automatically delivered to all parties, and a real time updated expiry report will be available to all parties via Digital Vega’s existing reporting portal.

Leading up to ”Cut Time”, the strike price of all expiring options will be continuously benchmarked, dynamically sorted and marked as either in or out of the money. At ”Cut Time”, each option will be revalued against the relevant cut rate and will be finally benchmarked with in the money options being automatically exercised and out of the money options being expired and abandoned. A detailed report of all events will then be immediately delivered to all participants

In Phase 2 of the project, Digital Vega will provide a FIX API connection to all participants should they require such connectivity. An Expiry Management API Specification will be made available to all participants for review shortly.