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Firms Look To Tackle Credit Options Overload


Derivative shops in Europe are looking for methods to stamp out potential trading mistakes on credit option exercise dates.


Derivative shops in Europe are looking for methods to stamp out potential trading mistakes on credit option exercise dates. The issue has become a pressing one for dealers who had to scramble to close trades after a sharp upsurge in the volume last quarter. Dealers across the market have reported a doubling of credit option trades in the past year--and that's an acute problem because European options are only exercisable at maturity. "There is a lot of room for error," said Hector Garcia, a credit options trader at The Royal Bank of Scotland in London.

A system to automatically exercise deep in-the-money options and the introduction of one-month expiry dates, akin to equity options have been floated as remedies. No market-wide solution has yet been discussed, but direction must come from both dealers and clients, Garcia said. Costas Katsileros, credit options trader atABN AMRO in London, said there was a glaring need for automatic exercising. "We need a system in the same way single name credit-default swaps can be settled through Bloomberg," he said.

Marcus Schüler, managing director of integrated credit marketing at Deutsche Bank in London, said the credit options market is growing and changes to automatic expiry were medium-term considerations. He noted a change to monthly expiry dates would be premature as unconfirmed credit-default swaps were a more pressing issue. "If we can't handle the CDS stuff I can't see how we can handle options," agreed Katsileros.

Garcia predicted firms would not be able to cope if there was a repeat of last quarter's volumes. High credit volatility in May--sparked by U.S. auto credit downgrades, rumors of leveraged buyouts and correlation panic--increased liquidity in the credit options market, he explained. The activity fuelled unexpected price fluctuations and traders faced a frenzy of confirming, booking and hedging hundreds of options swinging between in- and out-of-the-money.

All credit options in Europe, which are predominately bets on the volatility of the iTraxx HiVol and Crossover indices, are exercised on the 20th of March, June, September and December. Unlike American-style options, they can only be exercised on these dates, which puts greater pressure on traders to close them correctly within a five-hour window.

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