Developing a FX Trading Strategy

02/18/2008 12:00 am EST

Focus:

Alex Jacobson

Vice President, Education, International Securities Exchange, Inc.

Alex Jacobson, vice president, education, International Securities Exchange (ISE), showed attendees how to use foreign exchange options to improve their trading success…

Jacobson introduced his company, ISE, and told attendees that it is the largest equity options market in the US, and was also the first all-electronic market in the US for options. He commented that 40% of equity and ETF options are executed on the ISE.

About a year ago, ISE introduced options on foreign currencies, beginning with four—the Euro, British pound, Japanese yen, and Canadian dollar. Recently, they listed options on the Australian dollar and the Swiss franc.

Jacobson noted that these FX options are just like options on any other security, and can be traded in conventional brokerage security accounts, as long as you are options-approved. They are exchange-traded during the same hours as the US stock indexes. Additionally they are inexpensive and have low margin requirements.

Another new product that ISE introduced last year, is risk-based margining for customers in the US last year, which resulted in margin requirements declining dramatically—sometimes as much as 70-80%. Jacobson advised attendees who are interested in this product to talk with their brokers to see if it’s available through their firms.

Jacobson cautioned that because these options are very small instruments, friction—such as commissions, spreads, or technology costs—will have a big impact on your profit and loss. Consequently, the more you can minimize it, the more profitable you’ll be.

He added that the volatility of these exchange options is phenomenally low. He suggested that traders learn all you can about volatility, as it can be extremely important. For example, Jacobson told attendees that you can be right about trends but wrong about volatility, and your trade will underperform. However if you are wrong about the trend, and right about volatility, you may make a profit.

The options are dollar-relative, which is unique. One suggested method of playing is to buy calls if you think the US dollar is strengthening or puts if you believe foreign currencies will strengthen at the expense of the dollar.

As for his forecasts of the dollar, since the subprime and housing crises are not yet over, Jacobson sees no indication that the dollar will rally anytime in the near future, and will most likely continue to weaken.

Wrapping up his workshop, Jacobson gave attendees several examples, showing the resulting profitability if they had used these FX options in the past year. One last caution to traders—Jacobson suggested that if you want to trade at high volume levels, these options are not for you. You would be better off with forex and futures. FX options are better suited for trading the trend.

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