Boom in Currency Options Expected to Last
Dealing in currency options is expected to account for an increasing portion of foreign exchange revenues for many major banks, thanks to the dollar's volatility and advances in technical support systems, according to dealers and analysts.
The dollar's soaring volatility during the Gulf War and in the aftermath of German unification resulted in an unprecedented boom in options dealing in 1991. This boom is seen as likely to continue regardless of the dollar's direction.
"High-speed workstations and flexible software have made sophisticated trading and risk management possible," said Masato Kano, options trading manager at Fuji Bank in New York.
Managing Risk Exposure
Options trading has become the mainstay for managing risk exposure not only in currencies but also in a wide range of synthetic instruments, such as swaps and cap/floors, he said.
Many corporate clients, driven to the options market for the first time to hedge currency risks during the Gulf War, are likely to continue using options as a risk management tool, said David Durst, who heads foreign exchange derivatives at Credit Lyonnais in New York.
"Customers are getting more sophisticated," Mr. Durst said. "More chief financial officers are looking at options as an integral part of their forex management."
Forecast: More of the Same
Many options dealers expect the dollar to be equally volatile in 1992 as it's been in 1991, as the U.S. economy struggles to emerge from recession.
They said that with the Dec. 20 cut in the U.S. discount rate, which brought interest rates to their lowest levels in almost a generation, any new fiscal measures to boost the economy run the risk of rekindling inflation, which would put further pressure on the dollar.
Cause of Dollar's Volatility
U.S.-Japan trade frictions and President Bush's coming visit to Japan are likely to cause wide swings in dollar-yen exchange rates, Fuji's Mr. Kano said. "The market will overreact to any pronouncements by Japanese and U.S. officials."
"Overshooting" and "undershooting" on economic expectations and the subsequent correction are probably the main driving factors in the dollar's volatility in the absence of other geopolitical factors, said Gabriele Lamers, an international economist at Deutsche Bank in New York.
Easing of East-West tensions has contributed to the dollar's stability since 1987. But the disintegration of central planning in former eastern bloc countries has flooded the world market with minerals and other raw materials, depressing the dollar in which the commodities are priced, Ms. Lamers said.
The market may well oversell the dollar before economic recovery in industrialized countries brings demand for commodities, which in turn would trigger a dollar rebound, she added.
David Berry, a banking analyst with Keefe, Bruyette & Woods, said the expertise developed in derivatives trading over the past few years has begun to pay off.
"Declining cost of computing power and constant technological innovation have opened new possibilities," he said.
But "there's a learning curve, if you start from scratch," Mr. Berry said.