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Financial-Spread-Betting: Dr Michael Stumm and Dr Richard Olsen, please tell us a little about yourselves.
Michael: Richard is the financial engineer, while I am the computer engineer. Richard has a degree in economics and in law, whereas I have a degree in mathematics and computer science. Richard also operates a forex hedge fund, Olsen Invest, while I am also a professor in computer engineering at the University of Toronto.
Financial-Spread-Betting: Could you give us a brief overview of OANDA? When did OANDA opened its doors for business? How big is OANDA?
Michael: OANDA started in 1995 with a simple Web site consisting primarily of the OANDA Currency Converter. The company was incorporated in 1996. In 1999, we started work designing and implementing FXTrade. The demo version was released in 2000, and FXTrade was released in 2001. Over the years, there has been tremendous growth. OANDA is the number one Web site for currency exchange information, and OANDA Rate has become the touchstone of travelers, corporations, financial institutions, and even central banks. Today, FXTrade typically executes over 250,000 transactions a day.
Financial-Spread-Betting: How and who came with the initial idea for the development of FXBoxOption?
Richard: We wanted to simplify trading. Traditional margin based trading is simple on the face of it - you buy or sell, but to operate profitably, it takes a lot of discipline. The trader has to be very systematic, setting appropriate stop losses and take profits. Option trading is different. A trader can be more sophisticated with his trading strategy at the cost of extra complexity. Even though options are ideally suited for the layman as they limit risk, they have the disadvantage that they rapidly become too complex for the everyday man. So our idea was to go back to the drawing board and rethink the process of trading:
Whenever a trader opens a position, he starts out by having a view of the future. He has a certain expectation, of what is going to happen. For example, the market will trend sideways or break out, etc. The basic idea then was to allow the trader to draw a box around the next price target. He can then buy the box - this is how the idea of BoxOption came about. This was eight years ago.
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Financial-Spread-Betting: The boxoption service was opened and subsequently suspended for a long period of time. Why was this?
Richard: We initially test marketed the service on a trial basis in Switzerland. It was an immediate success with retail and professional traders. Based on the positive feedback, we then decided to integrate BoxOption into the FXTrade platform.
Financial-Spread-Betting: Why have you decided to re-launch it now?
Michael: We intended to launch the service quite some time ago. We were very busy with other important development projects and thus the release date was postponed. As with all things, it took us longer than we expected.
Financial-Spread-Betting: Tell us about the owners and principals of Oanda.
Richard: OANDA is a closely held company, founded by Michael and myself. Recently, Index Ventures, a European venture fund, acquired a small equity stake.
Financial-Spread-Betting: Digital Options are just one type of a new generation of options, called exotic options, that has emerged in the last 5-10 years. Could you give us an overview of OANDA's forex exotic options? How do they work?
Richard: OANDA offers two flavors of BoxOptions:
The principle is always the same: the trader draws a box somewhere in the future. With a hit box, he expects the price to hit the box. With a miss box, it is the reverse and he expects that the price will miss the box. He receives a payout, if the box is hit respectively missed.
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Financial-Spread-Betting: What instruments are available to trade at OANDA Box Option?
Michael: We currently offer BoxOptions for AUD-USD, EUR-USD, GBP-USD, USD-CAD and USD-JPY. Going forward, we plan to expand the coverage of currencies.
Financial-Spread-Betting: To whom do you think will the box options on OANDA.com appeal most? Is the platform targeted to retail investors?
Richard: BoxOption simiplifies trading: a trader does not have to think of stop losses and take profits --- the only task of the trader is to come up with a market view. In this sense, BoxOption is ideally suited for anyone, who is intent on speculating on the direction of the market. This can either be a professional trader or a typical retail customer
Financial-Spread-Betting: What has been the clients' reaction?
Michael: It has been very positive. Boxoption was released just recently. We were very surprised how many different clients bought BoxOptions. Clients just love the simplicity of the user interface.
Financial-Spread-Betting: What kind of box option contracts are available to trade? Do you plan on expanding your product range in the future to include more exotic options such as double no-touch and double touch?
Richard: Yes, we have plans to introduce additional option contracts. Prior to introducing more exotic options, we intend to launch put and call options.
Financial-Spread-Betting: Could you give us some insight about how a box option is priced? How are you able to price/offer forex options with such short term "target" time frames?
Richard: Pricing BoxOption is pretty complex. In principle, intra-day options are priced with the same formulas as inter-day options. There is one important difference. Intra-day, there is a strong 24 hour seasonality of volatility caused by the world turning around its own axis with traders going to work, taking a lunch break and then returning home. The changing presence of traders around the world has an impact on volatility. This 24 hour seasonal cycle of volatility has to be accounted for in the pricing formula of inta-day BoxOptions.
Financial-Spread-Betting: Do you use the Black and Scholes model for pricing options? Do you use formulas to price box options?
Richard: Yes, definitely. It is all fully quantitative. We could not do this without the math. The challenge for our platform was to price a BoxOption within a split second.
Financial-Spread-Betting: What uses do box options have? Please explain with examples.
Michael: There are quite a number of uses. Besides pure speculation, a BoxOption can be used for hedging; i.e., insuring your investments against a downturn.
Financial-Spread-Betting: However, critics of options say that if you are so unsure of your investment that you need a hedge, you shouldn't make the investment. Please comment.
Richard: BoxOptions can play a very important role in hedging positions.
Think of the following scenario:
You are long EUR-USD. For some reason or other, the market has gone against your position and has dropped considerably. You do not want to close your position at a loss, because you continue to believe that the market will go in your direction. You are, however, afraid that in a thin market the EUR-USD could spike lower. In such a scenario, you risk an even larger unrealized loss on your position. In this scenario, it can be prudent risk management to buy a BoxOption to hedge your position in case of a further sharp drop of EUR-USD. If you buy a BoxOption and the market bounces back up, you will have lost your premium on the BoxOption. However, if the EUR-USD drops lower, you will receive a large payout on the box compensating for all or part of the loss on your spot position. If you are lucky, the box is triggered and you have the rebound. BoxOption can smooth out the equity curve of your performance. Any trader, who evaluates return on a risk adjusted basis, will find BoxOption a very valuable hedging instrument.
Financial-Spread-Betting: Examining FXBoxOption carefully leads us to believe that box options share common characteristics with other similar products offered by other companies (such as RefcoSpot and Betonmarkets). However, the prices are often different. Doesn't this give space to potential arbitrage opportunities?
Richard: Yes, arbitrage is a possibility. Having said that, spreads on options tend to be wider than for traditional spot trading and thus arbitrage opportunities are less frequent.
Financial-Spread-Betting: Can clients open multiple concurrent opposite positions? Are clients allowed to open more than one FXBoxOption account?
Michael: Clients are not allowed to open more than one Account. However, they can open multiple concurrent opposite BoxOption positions.
Financial-Spread-Betting: Is it possible to time the markets? Or is it really too random especially over very short periods of time?
Richard: Yes, it is definitely possible to time the markets. The issue is that time does not flow smoothly, but accelerates and slows down. Successful traders tend to have a good intuition on when the speed to time changes. Traders that lose a lot of money are those that fail to pick up the changes in market pulse.
Financial-Spread-Betting: What are the most interesting findings you made, working with intraday data (High frequency data)?
Richard: First of all, tick by tick intra day data reveals a host of fascinating statistical properties that have not been researched in the past. It is a gold mine of information that people have failed to exploit. The most important features are: Financial markets are discontinuous, i.e. they represent a continuous sequence of explosions. Distributions of time series are non stationary, i.e. short-term price movements are far more fat tailed than longer term time intervals. This property is coupled with the scaling law property stating that over longer term time intervals price movements occur at the same pace. Typically, long-term volatility determines short-term volatility and only in rare occasions is there an inversion, where the short-term volatility predicts the long-term volatility.
Financial-Spread-Betting: Are your findings of use in regular day to day position trading?
Richard: Yes, definitely. Our trading strategy would not be feasible without our high frequency finance technology.
Financial-Spread-Betting: Why do you think it is important to deal with high frequency (intraday) data?
Richard: Over 90 percent of the transaction volume in foreign exchange and other markets are generated by short-term traders. Given this fact, I conjecture that it is not possible to extract meaningful information using just daily data. Traders observe financial markets on a continuous basis watching every price update, so our models have to do the same, i.e. process every price update.
Financial-Spread-Betting: Did you develop trading models and could you describe some ideas behind the trading models in short?
Richard: Yes, we build our trading models on the basis of the statistical properties of the financial markets. We generate 'alpha' or profits by providing a service - this service is to be liquidity providers to the financial market. We are not in the business to spot trends and make money on breakouts, but on identifying situations, where the trend has gone too far and an overshooting has occurred. We do this by analyzing, what the different groups of traders (short-term, portfolio managers and treasurers) do in the market.
Financial-Spread-Betting: Are the Box Option trade prices biased in favour of the house? How do you price box options?
Richard: OANDA is on the other side of every trade - hence if the customer has a successful BoxOption, OANDA has to pay out, while if the BoxOption is unsuccessful then OANDA obtains the premium. We believe, however, that in the long run all customers taken together will win more money than they lose. Accordingly, we consistently hedge our positions. In this sense, there is no thing as the price being biased in our favor - we have only one concern, namely that we have correctly priced the cost of hedging.
Financial-Spread-Betting: Are long contracts priced more expensively?
Michael: To the contrary - short-term BoxOptions are relatively more expensive. Short-term volatility is more difficult to forecast than long-term volatility.
Financial-Spread-Betting: Which factors influence the commissions?
Michael: We do not charge any commissions. We believe in simple pricing, where all our costs operational and hedging are incorporated in the price of the product.
Financial-Spread-Betting: What potential leverage is possible?
Michael: Maximum payout is a factor of 20 of the initial stake.
Financial-Spread-Betting: Is trading closed on weekends?
Michael: At this stage, we do not allow BoxOption purchases over the weekend (even though FXTrade is open for trading spot). Over time, this may change.
Financial-Spread-Betting: How are box options best described - a stock market game, betting or an investment?
Richard: BoxOption will mean different things to different traders.
Financial-Spread-Betting: Can a box option with a running time of 5 minutes be defined as a gamble?
Richard: Cynics can certainly view investment in BoxOptions as gambling in the same way they view speculation to be gambling. We see this differently. Speculators play a very important, well recognized role in the financial markets in that they are often counter party to those that need to hedge their risks, where the stability of a financial market is a function of the diversity of market participants. BoxOption contributes to diversity by enabling traders to put on different trades - hit or miss boxes at different levels. The launch of BoxOption has confirmed this - traders are putting on very different trades with hit and miss boxes being evenly balanced.
Financial-Spread-Betting: How is the volatility computed for such very short lifetime intraday options?
Richard: Very much the same way, as daily volatility is computed. The big difference is, however, that we compute intra-day volatility by processing every price tick. This adds to complexity - we have to account for the daily 24 hour seasonality, handle data errors of every sort and take into consideration the impact of news announcements.
Financial-Spread-Betting: What are the advantages and disadvantages of intraday options?
Michael: In the past, only the long-term trader had access to options to diversify his risk. Today, an intra-day trader can use BoxOption to manage risk. This is a big advantage, especially given the fact that short-term trading is much more risky than long-term trading due to the sharp spikes in volatility and thus has a greater demand for option trading than long-term traders. The disadvantage of every new product is that users have to become accustomed to a new product and have to build up trading experience.
Financial-Spread-Betting: And what are the advantages of using box options over simply choosing a direction and putting on a trade?
Richard: There is no such thing as a simple trade of choosing a direction and putting on a trade. To survive in the market, the trader has to implement rigorous money management rules. With BoxOptions this is far simpler - the trader can just concentrate his energy in correctly forecasting the market. BoxOption automatically handles the issues of stop loss, take profit, etc.
Financial-Spread-Betting: Are there any differences between buying box options in the demo account as opposed to the live account?
Michael: No none at all. Having said that, we always test new versions of software on the demo system first, before releasing it to FXTrade. Hence, there may be minor differences over a period of a few weeks.
Financial-Spread-Betting: Do you offer limit and take profit orders for picking profits/entering box trades? If not, do you plan to offer them sometime in the future?
Richard: At this stage, these tools are not yet available. This feature request will depend on customer feedback. If our users want this feature, we will develop it for them.
Financial-Spread-Betting: Rumour has it that you hedge box options by trading spot. Please explain your hedging strategy in more detail.
Michael: This is correct. We rigorously hedge the exposure of BoxOptions. We do this, because we want to minimize risk and do not want to be on the 'other side' of the trade.
Financial-Spread-Betting: Currently OANDA only lets you buy options from the primary market maker (i.e. OANDA), but not from other traders and does not allow us to sell options to other traders. This means that one can only trade against the house and if I buy an option for $100 and want to sell it off the next day I can sell it back only to OANDA at the price you are willing to pay for it. Do you think this will change in the future (i.e. FXBoxOption be transformed into an exchange)?
Richard: In the future, the market will gravitate to a state that is cost effective to the end user. At this stage, I am not convinced that an exchange is more efficient. A single market maker can manage risk more efficiently and thus at a lower cost to the end user than an exchange with a large number of market makers, where no one has the necessary information to offer the best return on investment.
Financial-Spread-Betting: Will you stop clients who are day-trading effectively? We have encountered traders who have worked hard to develop systems that were consistently profitable only to find that the platform broker/market maker (not OANDA) abruptly changed the rules thus killing their trading systems. Please comment.
Michael: We do not lock out customers who have successful trading strategies. To the contrary: successful traders trade more and for a longer period of time, so we want those type of clients. Since we take extra care to hedge every position, OANDA wins if its clients win.
Financial-Spread-Betting: Do you accept International clients? In which base currencies can clients trade box options?
Michael: OANDA has many international clients.
Financial-Spread-Betting: What is the minimum deposit and minimum/maximum investments (if there are any)?
Michael: There is no minimum. The minimum investment is 1 USD with the maximum being 2000 USD. The maximum will increase in the future.
Financial-Spread-Betting: Can clients open multiple positions in the same currency pair (thereby sidestepping the maximum investment)?
Richard: Yes.
Financial-Spread-Betting: Are box options unavailable to Canadian residents? If so what's the reason for this?
Michael: Unfortunately, we cannot offer BoxOptions to Canadian residents at this time. This will change, when we have clarified the regulatory issues.
Financial-Spread-Betting: Where exactly is your business located? Do you have any international offices?
Richard: We have offices in New York, Toronto and Zurich, Switzerland. Much of our operations is based in Toronto.
Financial-Spread-Betting: Under which jurisdiction and license does BoxOptions operate?
Michael: OANDA is CFTC regulated and a member of the NFA in the US.
Financial-Spread-Betting: Do you have offices in the UK?
Richard: No - not at this stage.
Financial-Spread-Betting: Is interest paid on the balance of the accounts?
Michael: Yes, it is.
Financial-Spread-Betting: How big is your client base?
Richard: OANDA's client base is large. Each month over 1M unique visitors view our Web content, and over 85'000 organizations world wide have licensed our currency converter tools
Financial-Spread-Betting: How do you make most of your money?
Michael: The FXTrade platform is our largest revenue generator.
Financial-Spread-Betting: Who is predominantly making up your customer base at this time?
Michael: We have many retail customers but also corporations, smaller hedge funds, and financial institutions that use FXTrade for liquidity.
Financial-Spread-Betting: Do you trade on a personal basis? Have you made any mistakes along the way that you have learned from? If so, would you describe them?
Richard: I myself have money invested in the Olsen Investment managed account program. My biggest mistake in trading has been to enter too big a position initially. This is the most common mistake that all traders make. They are so convinced of the accuracy of their market forecast that their first trade is too big. The inevitable will happen, the market will turn against them and they will have to bail out at the worst point in time.
Financial-Spread-Betting: There are many sayings in the markets; do you have a favourite one?
Richard: It is easy to make a small fortune - start with a big one.
Financial-Spread-Betting: Is OANDA profitable? How many clients do you have? What are your current daily trading volumes?
Financial-Spread-Betting: Do you think there is a chance for the average trader to survive in the markets even if he has not a deep academic background?
Richard: Yes, definitely. I am not a great believer of an academic background. It is important to have a good common sense and be extremely disciplined in one's trading strategy.
Financial-Spread-Betting: What advice would you give to an average trader?
Richard: The typical mistake of a trader is to commit too much money to the first trade and have too high exposure. In financial markets, it is important not to become boxed in, i.e. to reach the maximum risk limits.
Michael: OANDA is profitable and has been for several years. Typically, OANDA FXTrade executes over 250,000 transactions for its clients each day. In total, OANDA has executed over 71M FXTrade transactions.
Financial-Spread-Betting: Do you operate any other sites besides http://www.boxoption.com
Michael: All our sites are pretty integrated. There's http://www.oanda.com, our currency information site, http://fxtrade.com, our forex trading site, http://fxgame.com, our demo trading site.
Financial-Spread-Betting: What challenges do you see ahead?
Richard: To tighten the spread of EUR-USD to as low as 0.1 basis points.
Financial-Spread-Betting: Any other comment you want to make?
Richard: It's going to be interesting to see how the forex markets will change over the next few years.
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