The Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA) have applied several new regulations to the options market in London.
These changes impact both retail and institutional traders.
Reduce systematic risk
The FCA has said that the purpose of these changes is to reduce systemic risk within the market, particularly as electronic trading platforms such as MT4 or cTrader become prevalent among CTAs.
One of the first significant changes is that all positions, whether short or long, must be squared off at some point before expiry, either by taking an opposite position or closing out one side. If a trader fails to do this, their broker will automatically close it for them at a predetermined time before expiry.
It prevents sharp moves in the market if a trader has one side of their position left open at expiry.
Disclose individual positions
It has also been made mandatory for traders to disclose all individual positions before entering into transactions, allowing brokers to check whether clients are within their exposure limit.
It will help reduce trading positions that are too large for an account.
You should disclose all existing positions; however, this needs only once per month.
The FCA has said that this is because they are aware that there are large numbers of active traders involved in the options market who may not trade every day, and therefore it would be difficult to track each position daily.
However, if positions become very significant, brokers will be required to report this regularly.
Changes in the Options market
The options market in London has had some significant changes over the last year that are designed for the benefit of all traders after years of warnings about increasing systemic risk within the derivatives industry.
FCA chief executive Martin Wheatley said it was essential, particularly with electronic trading platforms becoming more popular, that brokers and clients were not left exposed by unreported positions at expiry.
With these new regulations coming into effect now, all parties involved should have more information available before trading commences.
It would make it harder for CTAs to enter into transactions they cannot afford, which is good news for smaller CTA firms that they could push out of business if they incurred significant losses due to trader error.
The changes have been designed to limit systemic risk as much as possible by giving brokers the option to trigger an exit from a client’s position if they are not adhering to regulations, reducing the possibility of significant losses being incurred by a single party.
Reduce anonymity for traders
The reduction in anonymity for traders will likely mean that it is easier to identify a trader who has breached a certain percentage of their agreed exposure limits and then apply further restrictions on their account until this has been resolved.
However, some smaller CTA firms may choose to close accounts rather than force traders into compliance with stricter documentation requirements, reducing liquidity within the options market.
These new changes come when the derivatives industry is worth over $700 trillion worldwide; however, this includes all derivative types, so it does not solely reflect the options market.
While it would be tough to put a figure on the size of the options market in London alone, hundreds of CTA firms across Europe use this as their primary trading strategy.
Increase safety and stability
The new regulations should increase the safety and stability of the options trading market, which will only benefit traders in future years.
Martin Wheatley said that these changes were an essential step for reducing systemic risk, but many more still needed to be made within the derivatives industry as a whole.
It is especially true when credit default swaps (CDS) are currently unregulated, which means they have very little oversight for activity or position limits.
However, some believe this is insufficient and have called on regulators to focus on the clearinghouses themselves.
The main reason is that they are currently unregulated by any single body, forcing them to comply with every country’s laws instead of a singular overarching framework.