The New York Board of Trade has launched a new index that offers contracts on the trade-weighted euro, satisfying growing demand from its European clients, notably those that trade on the futures exchange’s sister trading floor in Dublin, Ireland. The options started trading on the New York floor last Friday and in Dublin yesterday. While most banks offer similar, albeit customized, indexes based on the euro, this will be the first index available to the public, adding further transparency to the fairly opaque market of currency trading.
The futures exchange has traded a similar index based on the dollar for nearly two decades; the euro is the second largest currency in the world behind the dollar at 37% of all foreign exchange transactions. Year on year trading volume is up more than 48%, with USDX contracts up 51%, according to the NYBOT. The New York futures exchange is banking on the success currency trading has witnessed in the last two years with its new offering.
Demand for a euro index is still largely focused in Europe, but it is growing as investors seek ways to hedge currencies amid a weakening dollar. “We had demand from many European clients and from our sister trading floor in Dublin, Ireland,” says Anthony Scamaradella, v.p. of marketing, “and a lot of our existing dollar-index clients believe it’s beneficial to have a euro index.”
In the Finex Euro Currency Index (ECX, symbol E), the euro will be trade-weighted against the U.S. dollar, sterling, yen, Swiss franc and Swedish krona. Futures and options contracts will have a trading size of 1,000 euros times the index. Though the European Central Bank uses 23 currencies to calculate the euro’s exchange rate, the index is limited to these five currencies for price efficiency.
“Research showed these five currencies are highly investible, tradable and have very sound interest rate structures within those countries,” Scamaradella says. “The combination in their respective weights have a positive correlation in excess of 99, with an entire EER basket of 23. It’s really an economy of scale here to modify the basket and “optimize” the basket so it could be efficiently priced. Otherwise a risk premium would have to be associated with pricing the entire 23 currencies to take in their volatility and lack of liquidity.
Speaking of liquidity, the question inevitably arises whether another index might fail to generate enough trading volumes to create sufficient liquidity. “Any new contract on any exchange or at any institution that creates a new product keeps their fingers crossed and holds their breath that they’re going to be successful immediately,” retorts Scamaradella. “The precedent that we’re hinging some of our hopes and aspirations on is the success of the dollar index.”
In theory this is the same type of product with the same participants and the same price makers, he adds. “There should never be an issue in getting a price or in getting any volume off it.”
Unlike other equity indices, the ECX is not wedded to rebalancing requirements, meaning the euro could be trade-weighted against other currencies depending on ECB weighting changes, for instance, or other changes in currency markets. The index mirrors the traditional baskets of international fixed income and international equity portfolios so there is a place for it in as a macro currency hedge on some of these more traditional international portfolios.