FX Option Volume

Abstract

We study the information content of over-the-counter foreign exchange (FX) option volume using a granular dataset with counterparty identities and contract characteristics. We find that FX option volume negatively predicts future exchange rates, especially when the concentration of informed investors increases, during periods of high dollar demand, and for options offering higher leverage opportunities. Our findings support an asymmetric information model, where informed traders choose whether to trade in the option market to exploit their information advantage. We also document that hedge funds and real money investors display superior skills at predicting future exchange rates compared to less sophisticated players.

Keywords: Exchange rates, Currency Returns, Foreign Exchange Option, Informed Trading, Dollar Demand.

JEL Classification: F31, G12, G14, G15