In the 1980s, fresh faced traders eager to earn a buck headed to Philadelphia having never even visited the city before. Attracted by the lure of en vogue options trading these men and women pioneered an asset class. But having become the most profitable departments in many trading houses, their initial popularity wore off and currency options which had once broken records in their trade sizes soon disappeared to the neverland from which they had arisen. Then, 16 years after they were first launched Philadelphia Stock Exchange (Phlx) came back with a new breed of world currency options in January 2007 and earlier this month launched FLEX options with the aim of recapturing some of that success and this time, doing it for the long haul.

In 1982, Phlx created a product out of nothing. Just six years later in 1998 they were trading in volumes as high as $4 billion per day in underlying value. In fact, it was the success that Phlx had with currency options which spurred the creation of Philadelphia Board of Trade in 1985 to trade currency and other futures products.

Although a storming success in their honeymoon years, the popularity of the original products did not hold out. “In truth, we all knew in our hearts that the FX market was dominated by the banks and their customers. Banks used the exchange to manage the risk that they weren’t all that comfortable with managing themselves. But it didn’t take long for the banks to get their confidence,” says one trader who was among the first to trade the currency options. Further explaining the demise of the contracts he continues: “Quite frankly, Phlx failed to maintain the competitive advantage of that programme. They didn’t provide electronic execution and the bid/offer spreads weren’t as close as the interbank market.” This failure to keep up with technology combined with the fact that European countries were moving towards a single currency and therefore much of the function of the stock exchange’s products were becoming redundant.

Then in January 2007, Phlx launched its new version of its world currency options, this time aimed at allowing retail investors, currency traders, asset managers and corporations to implement foreign exchange into their investment strategies. And, it appears that these are on an exponential growth curve. Having started from scratch last January, this year’s mid February open interest stood above 900,000. “This time they’ve done exactly what they should have done in the first place and aimed it for the retail investor,” says the former trader. If retail investors are bullish on the direction of a particular currency, they only need to buy a call and visa versa. This affords retail investors the ability to take long term positions with a pre-defined risk and let the market play out the projected scenario.

But now they face a new challenge, by having an exact expiration and an exact settlement price they are aiming to provide an exact tool for institutions to hedge their FX risks. “The FLEX options, launched on February 25, are primarily suited to institutional traders as it gives them the ability to finely tune their hedge. The retail customer will continue to utilise the existing contract that they have,” says Daniel Carrigan, vice president of new product development at Philadelphia Stock Exchange.

“We are the first exchange to put forward this option for foreign currency options. It will appeal to traders operating in the OTC market but who want a CCP and end of day mark to market.”

One commentator close to the options exchange landscape says: “The new contracts have turned out to be a very good business for retail and the FLEX could be very successful for the institutional side.” The contracts are dollar-settled on the euro, British pound, Australian dollar, Canadian dollar, Swiss franc and Japanese yen. From January 2, currency options have also been offered in penny increments to complement the existing nickel and dime offerings.

However, although supportive others are more hesitant on the future success. “We are happy to support it if the institutional customer base is interested. Nobody has told me there is an overriding interest for it but we can do it without a problem,” says one trader from an investment bank. Although praising its transparency and ability to keep counterparties anonymous, the trader worries as to the liquidity the contract will have initially. “Adding FLEX is great but the really interesting battle over the next few years is showing how much liquidity the exchanges can actually grow in the instructional marketplace,” he adds.

Phlx’s plans for its world currency options does not stop there. The exchange is now looking at launching Brazilian, Russian, Indian and Chinese contracts to take advantage of investor appetite for the so-called BRIC emerging market countries. Depending on regulatory approval market commentators have speculated that these may be out before the year end.

Chicago Board Options Exchange pioneered the concept of customisable options trading in 1993. Then, in 2006, it signed an agreement with Cinnober for it to provide the technology for the first US internet, fully electronic trading mechanism for FLEX equity and index options. However, these didn’t receive regulatory approval until November 2007. CBOE had the same hope of attracting volume out of the CBOE market and on to exchange. But currency has always been an OTC dominated market and whether the institutions will get on board is merely a game of wait and see.

The value proposition of marketing these products to institutions varies widely from making it a success for the retail sector. The lure of a central clearinghouse may be enough, especially in these times of heightened risk management awareness but whether the spreads can be tight enough is a game that will play out in the coming months. But with its legacy deeply entrenched in currency options, if any exchange can make a success of these products Phlx can.