NCFX Options Cut: A new market standard

NCFX Options Cut: A new market standard

The NCFX FX Spot mid-rate benchmarks are becoming the preferred standard for clearing and determining automated FX option expiries. In the decentralized and fragmented FX market, reaching consensus on clearing rates is a complex task. A transparent and reliable benchmark is essential, and the NCFX Options Cut is emerging as an effective solution.  FX markets rely on two concurrent systems for price discovery: the continuous auction market and the fixing process (call market). This dual market structure creates challenges for selecting benchmarks, particularly in managing risks like market manipulation and pin risk. This case examines the NCFX Options Cut methodology and compares it to alternatives such as TWAP, Median, and VWAP, highlighting its advantages in delivering a fair, transparent, and automated approach to FX option expiries. 

Independent benchmarks in a dual market structure 

The NCFX FX Spot mid-rate benchmarks were developed after the WMR and Libor fixing scandals in 2013. In FX markets, the continuous auction model enables dynamic price discovery, where prices shift throughout the day based on market conditions, order flows, and news. In contrast, the FX fix aggregates orders at specific times to produce a single price as a reference for transactions.  This dual structure can lead to discrepancies between the continuously fluctuating auction prices and the fixed price from the call market, especially during option expiries. These differences may result in disputes over whether the fix accurately reflects the true market conditions, making it difficult to settle contracts, value positions, and manage pin risk effectively.

Addressing pin risk and market manipulation 

Pin risk is a critical challenge in FX option expiries, occurring when the market price remains near the strike price as options approach expiration. This creates uncertainty and the potential for disputes in automated processes. The NCFX Options Cut addresses this issue by providing continuous visibility of mid-rate prices leading up to the expiry, allowing participants to assess market conditions accurately.  “The transparency of the NCFX Options Cut is key, as it enables real-time observation of price formation,” says Xavier Porterfield, Head of Research at New Change FX. This allows participants to hedge positions effectively and enhances fairness by making any attempts at market manipulation more apparent. In contrast, benchmarks like TWAP, which aggregate prices over time, can obscure manipulation because prices are averaged over time. 

Ensuring fairness, transparency, and automation 

The NCFX Options Cut has gained widespread adoption, with key participants like LSEG, Digital Vega, and SpectrAxe utilizing it for FX option expiries. The continuous price stream provided by NCFX allows participants to monitor market conditions accurately, reducing operational risks.  Mark Suter, CEO of Digital Vega, praised the NCFX service: “We’ve been using the New Change Options Cut for over three years, processing more than 400 expiries in seconds on busy days. The service has significantly reduced operational risk and costs.”  This growing adoption reflects the FX market’s need for transparent, automated, and fair benchmarks. The continuous feed of observable prices minimizes the risks of pin risk and manipulation, making the NCFX methodology a robust and reliable benchmark for automated FX option expiries. 

Conclusion 

The NCFX FX Spot mid-rate benchmark offers a superior alternative to traditional methods like TWAP and VWAP. With its focus on transparency, continuous price visibility, and fairness, NCFX provides a reliable and accurate solution for determining FX option expiries. Its growing market acceptance underscores its effectiveness in addressing the challenges of pin risk and manipulation, ensuring a fair and efficient FX market. 

For more information please contact: info@newchangefx.com or visit www.newchangefx.com

PRODUCT REVIEW Xavier Porterfield 28 NOVEMBER 2024 e-FOREX NOVEMBER 2024 e-FOREX 29

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