FX Options company Sentry Derivatives has recently branched further into the retail FX space, a notable event having been the provision of the company’s strategic partnership with AvaTrade in April this year, enabling the launch of FX Options by AvaTrade in certain locations.
The company was founded in 2010 as a result of a joint venture between Steven Reiter, an options trader whose career includes a stint in Wall Street and Ava Financial. In this week’s Forex Magnates Executive Interview, Mr. Reiter, from within his position as CEO of Sentry Derivatives, elaborates on the company’s position within the industry, its liquidity provision offering and how FX options is able to carve out further niches within the global retail FX business.
Please elaborate on your career background, and what led you to your position at Sentry Derivatives?
After graduating from Penn’s Wharton School I went straight to Wall Street, having known from a young age that I wanted to be involved in trading and technology. I joined Salomon Brothers as a “quant”, developing derivatives strategies and pricing models to help customers hedge interest rate and equity risk. After nine years in New York, Tokyo, and London, I was asked to head Salomon’s interest rate options trading desk in New York. After Salomon was acquired by Citibank, new opportunities opened up, and in 2002 I returned to London as Global Head of FX Options, my first significant foray into FX.
After twenty years, it was time for a new start. I knew I wanted to bring FX Options trading online to the broader retail and smaller professional market. I needed an established partner who knew the service and marketing side of the online FX business. When a venture capital firm introduced me to the founders of AvaTrade, we knew we had the foundation for a great business and created Sentry Derivatives.
Upon assuming your position as Co-Founder and CEO of Sentry Derivatives, what did you set out to achieve initially, and how did you go about it?
Our goal is to open up the world’s largest and most liquid options market to retail and professional traders in a format they already know – online margin trading. Few online brokers have the knowledge to achieve this on their own, and as options will only be a part of their business,they may not see the value in even trying. Our plan was to bring the entire package of platform, liquidity, integration and service to online brokers, so they can deliver a full suite to their customers without having to invest in their own trading staff and risk management solutions.
To do this, we worked with FX Bridge Technologies, tailoring their platform to our needs. We built a robust risk management system so that we could add our liquidity to that of five major banks, allowing us to offer both tiny and large trades. We built integration tools so that we could bring the platform and liquidity to retail and professional clients via a number of online FX businesses.
For liquidity, we secured one of the largest global banks as our prime broker, and added options liquidity from four additional major global banks (for now) via fully integrated APIs, as well as their own trading portals. To this we add our own liquidity to ensure that we can accommodate the smaller retail flows, which we aggregate and hedge with these same banks.
We launched with AvaTrade earlier this year, and are now working on providing our service through additional brokers – both existing retail FX brokers who want to add a professional options product, and also via traditional institutional brokers looking for an online complement to their voice broking activities. Our platform is very attractive to small funds and family offices without access to a prime broker, as we are effectively offering an ECN with multi-bank liquidity, online 24/5. It is a great way to trade options on 5, 10, 20 million or more without having to call or log in to five different bank platforms, and as a margin platform trading is anonymous.
Please give us an insight into how the retail market has taken to the availability of options, as it is relatively uncommon among retail traders. Do most see it as a predominantly institutional product and shy away from it, or does the client base consist of equities traders rather than retail FX traders?
Without question, the product is most popular with experienced options traders. They appreciate the earning potential from trading options and immediately understand this FX version. It is a very convenient way for them to trade, great prices streaming 24/5, with risk management tools, spot FX and options in one place.
For traders with no options knowledge, of course there is a learning curve. For this purpose we have the fully functional demo account offering. There is plenty of educational material on the web, and we are developing material to be integrated with partner websites and within the platform itself.
There is indeed more crossover from equity options than there is from spot FX, as a great number of FX traders are inexperienced with options. But I believe that over time, as more educational content is developed and traders get comfortable via the demo accounts, we will see more retail traders getting involved in FX options. Perhaps they will even start crossing over from binary options, a product that is popular for its simplicity, but which does not offer the powerful portfolio structuring possible with standard “vanilla” calls and puts.
Our audience is not just retail, as I mentioned earlier. There are many types of investors not being served by the big banks and brokers, and a robust multi-bank online trading platform is an unbeatable way to trade FX options. We offer a great service to any fund or institution which does not have a prime broker, or simply appreciates the convenience and transparency of using an anonymous online platform.
Since Sentry Derivatives provided the platform and trading environment for AvaTrade’s AvaOptions product, what has the market response been? What are the volumes being traded on the options platform each month compared to the FX platform, and what audience is it aimed at?
In the case of AvaTrade, it is too soon to tell, as the launch has been limited to a few countries; AvaTrade is now preparing to launch the product in Europe, and they are not in the US. The product’s initial appeal will be with traders familiar with options trading, and they are going to be found in countries with very developed financial markets. Meanwhile, options trading volumes and customer deposits have increased more than 50% almost every month since launch.
We are eager to work with more brokers; AvaTrade is just our first partner. We are in discussions with institutional brokers, especially middle-market brokers, about complementing their services, as they focus on investors who are already familiar with options. In addition, there are many options educational sites, which can be terrific affiliates for any broker offering the product.
It would be of interest to gain some detail about Sentry Derivatives white label offering. What is the cost model and how does it work in terms of capitalization?
For an existing broker wishing to add our platform and liquidity, we can work on revenue share or markup, keeping upfront costs minimal. We want to make this easy for our partners.
For capitalization, all trades of that broker’s customers will flow through the broker’s omnibus account, and the platform will calculate the net required margin. As some risk will be offsetting, the margin required should be less than the underlying customer deposits.
Which regional markets are the most lucrative for Sentry Derivatives? How does the cost of regulation in each region compare with the quality and longevity of the client base?
I can speak of two trends. First, Asian investors are very eager to use FX Options – I saw these flows from the Private Banking divisions of many banks when I was with Citibank, from both dual currency deposits and from outright trades.
Regulatory costs will vary by country. Second, as more experienced traders are going to be found in countries with very developed financial markets, such as Europe and the US, regulatory costs are likely to be higher – offset by larger spreads than spot FX, and reduced customer acquisition costs, as options are a new area.
Options embody the phrase “time is money”, and time is a core component of any options trade. Therefore, options traders have longer time horizons, and can structure their trades to weather bad storms. In general options traders have a long lifetime, as options offer them many ways to manage risk.
With regard to the trading platform itself, was it designed as a bespoke platform purely for Sentry Derivatives business requirements, or is it an off-the-shelf platform that has been customized to suit FX Options in the retail market? Please detail its functionality and any differences in operation from an FX trading platform.
The platform was built by FX Bridge Technologies from the ground up for options trading, and of course it includes FX Spot trading as well. It can even be extended to CFDs. Of course, it is the options trading that sets it apart from other FX platforms. It includes streaming spot and options prices, live P&L, charts, professional risk management tools that allow customers to explore their combined spot and options risk, to add simulated trades, and to execute FX and option orders with great flexibility.
We worked intensively for two years with FX Bridge on additional features to meet our specific requirements and integration needs, and lent our experience to theirs to improve the platform. We added our own back end for risk management and built additional integration tools.
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Most importantly, we set up relationships with our liquidity suppliers and prime broker, and established our own risk-taking capability so we could accommodate smaller trades. Most of our trades are automatically routed to our five bank liquidity suppliers, making the platform an ECN for FX Options – the first of its kind in a margin format (which makes it anonymous as well), and giving the benefits of prime brokerage to every one of our end users, including smaller traders who benefit from our great pricing and transparency.
If an FX broker wishes to offer FX Options via a white label offering from Sentry Derivatives, how does the back end integration work? Does it provide a shared wallet so that a broker can offer options to its existing FX client base, and how is it capitalized? Is it paid for on volume, or spread, and are there any fixed up-front costs to integrate it into an existing FX broker’s system?
We have built tools to connect websites, CRMs, and other applications to the trading platform so that integration with an existing business is straightforward. Of course, there are many different levels of integration possible. We can work with a broker who does not actually accept the customer deposits, or with an established full-service broker who wants to simply add the platform.
We have not yet built a shared wallet capability. Customers can trade both FX and FX Options on the platform, and benefit from risk-based margining (margin calculations look at all positions for each currency pair, so a long spot position will offset a short call option for efficient use of collateral). We could not manage that in real time if a customer had his FX positions on one platform, and options positions on ours.
Of course, many brokers offer multiple trading platforms, and moving collateral from one to another is a feature of many websites, such as AvaTrade.
Sentry Derivatives offers liquidity provision. How is the liquidity sourced and what is the advantage of this rather than taking a full solution from other established institutional firms via a bridge such as Leverate, LMAX or Sucden?
Our FX Options liquidity comes from direct connectivity to five of the largest global investment banks, with all trades cleared through one of them, our prime broker. We have access to additional liquidity as well, and will add more direct connectivity as volumes grow.
Traders using our platform for trade sizes greater than $1 million can enjoy “No dealing desk” execution. For smaller trades, we add our own liquidity, so we can service small retail trades as well. None of the other institutions or market makers offers such a complete liquidity service, online or offline.
We combine all this liquidity with the online margin trading platform, partner with brokers (AvaTrade is our first), and thus offer branded margin-based anonymous multibank liquidity for FX and FX Options trading.
What differentiates long-term investors who set calls and puts with a one-year expiry from short term FX traders? How does Sentry Derivatives provide market information that can lead an investor to set an expiry date one year into the future?
In trading spot FX, traders can do one of two trades: buy, or sell. They can set entry and exit points using all types of orders, but the risk is still one or the other – long or short. With options, traders have many more ways to profit from their views.
The typical FX trader has a very short horizon because he does not have tools to last through market turbulence. He can only buy or sell, setting entry and exit points using various types of orders.
With options, traders have much more flexibility to structure trades to match their views, balancing risk and reward.
The long-term investor selling both one-year calls and puts is trying to profit from his view that the underlying FX rate will be range-bound at the end of the year. He earns premium for selling this protection. For example, with EURUSD spot at 1.3520 today, if he sells a one-year EURUSD 1.30 Put and a EURUSD 1.40 Call, he will receive 500 pips of premium. This makes his break-even range in one year 1.2500-1.4500. He profits if EURUSD finishes anywhere in that 2000 pip range in one year. This trade cannot be replicated by the typical FX trader with spot trading.
Traders can also sell options to establish entry point to spot trades. A spot trader who wants to buy EURUSD below 1.32 in the next month can place a limit buy order at 1.32. An options trader can sell a EURUSD 1.32 Put option for one month, earning 40 pips. In one month, if spot is at or below 1.32, then the spot trader owns EURUSD at 1.32, while the option trader’s all-in cost is 1.3160, having earned the premium. And if spot never gets to that level, the options trader still gets to keep those 40 pips. He is getting paid for leaving a buy order.
Traders buy options as well, either to protect business profits or investment exposures, to reduce downside risk on other trades, or simply to express a leveraged view that a currency pair will move in one direction or another.
One last creative example of how traders use options is to establish correlation risk in specific markets. Suppose a trader wishes to belong to EURGBP only in a market where the USD is weak. One idea is to buy EURUSD calls, and sell GBPUSD calls. If the USD is weak, he has net long exposure to the EURGBP spot rate; if the USD is strong, both options will move out-of-the-money, and the trader will have no exposure at expiration. If GBPUSD implied volatilities are higher than EURUSD, a trader can structure this trade for a net credit, while creating an advantageous EURGBP entry point to the trade he believes in.
Sentry provides market information via the options trading platform, which gives pricing information for thousands of options, historical charts and data, and an integrated powerful Risk Manager that allows a trader to see all the risks of his trades. We are working on some relative value tools and trading signals to build into the trading platform, and should have these available by the end of the year. Individual traders will be able to combine these signals with their market views and risk tolerance in order to structure their own winning portfolios.
Sentry does not provide market advice; we provide a branded platform with tools, pricing and liquidity to brokers who offer trading to their clients. These brokers can offer trading advice in line with their own abilities and regulations.
In terms of regulation, how does the regulator consider options firms, and do they need to maintain the same capital requirements as FX companies in most jurisdictions? Are portfolio managers considered financial advisers and therefore need to be licensed by regulatory authorities?
Regulations vary of course, but in most jurisdictions, firms that are licensed to offer FX spot trading are also licensed to offer FX options trading, and where a portfolio manager is allowed to trade spot FX for a client, he is usually allowed to trade FX Options as well. In the US, a broker that offers FX Options must be registered as a swaps dealer if it trades more than $10bn of options in any given year.
Where do you see the options markets expanding the fastest in the near future, and how will this occur?
We fill a gap in the market for experienced traders, both retail and institutional, looking for liquidity and transparency online, who don’t have access to, or don’t want, five bank trading platforms and/ or a prime broker. So I think we’ll see our quickest success in that space.
Beyond this, FX Options trading will grow fastest in countries where traders have options experience. I expect to see our volumes grow as IBs and options educational websites pick up on the great opportunity offered by our product, which opens up the largest options market in the world to so many new users, just as the first online FX margin trading platforms did about ten years ago.
According to the BIS survey just released, the FX Options market grew 60% over the past three years, and now amounts to more than $330 billion per day. Options are a core component of the market, clearly fulfilling specific needs therefore, it is natural to expect more traders to get involved.
What is Sentry Derivatives plan for the remainder of 2013?
I’m glad you asked! We are looking for some smart, reputable brokers to work with – both those serving the middle markets, and retail oriented brokers who want to differentiate themselves with a professional product delivered professionally.
We are also working on adding options on precious metals to the platform very soon.