A Currency Options Primer: (The Wiley Finance Series)

A quick and concise guide to currency options An understanding of currency options is essential for those working in investment and foreign exchange. A Currency Options Primer sets out to give readers a clear guide to how the currency option market functions, offering practical advice on mastering the necessary components and concepts for fully understanding the workings of this market.

Table of Contents:
Disclaimer xi 1 Introduction 1 1.1 The forward foreign exchange market 1 1.2 The currency options market 1 1.3 The alternatives to currency options 2 1.4 The users 2 1.5 Whose domain? 2 PART I MARKET OVERVIEW 3 2 The Foreign Exchange Market 5 2.1 Twenty-four-hour global market 5 2.2 Value terms 5 2.3 Coffee houses 6 2.4 Spot and forward market 6 2.5 Alternative markets 7 2.6 Currency options 7 2.7 Concluding remarks 8 3 A Brief History of the Market 9 3.1 The barter system 9 3.2 The introduction of coinage 9 3.3 The expanding British Empire 10 3.4 The gold standard 10 3.5 The Bretton Woods system 11 3.6 The International Monetary Fund and the World Bank 11 3.7 The dollar rules OK 12 3.8 Special drawing rights 12 3.9 A dollar problem 13 3.10 The Smithsonian agreement 13 3.11 The snake 13 3.12 The dirty float 13 3.13 The European Monetary System 14 3.14 The Exchange Rate Mechanism 14 3.15 The European Currency Unit 15 3.16 The Maastricht Treaty 15 3.17 The Treaty of Rome 15 3.18 Economic reform 16 3.19 A common monetary policy 16 3.20 A single currency 16 3.21 Currency options 18 3.22 Concluding remarks 20 4 Market Overview 21 4.1 Global market 21 4.2 No physical trading floor 21 4.3 A “perfect” market 21 4.4 The main instruments 22 4.5 Comparisons of options with spot and forwards 23 4.6 The dollar’s role 24 4.7 Widely traded currency pairs 24 4.8 Concluding remarks 25 5 Major Participants 27 5.1 Governments 27 5.2 Banks 27 5.3 Brokering houses 29 5.4 International Monetary Market 29 5.5 Money managers 29 5.6 Corporations 29 5.7 Retail clients 29 5.8 Others 30 5.9 Speculators 30 5.10 Trade and financial flows 30 6 Roles Played 33 6.1 Market makers 33 6.2 Price takers 33 6.3 A number of roles 33 6.4 A number of roles – options 34 6.5 Concluding remarks 34 7 Purposes 35 7.1 Commercial transactions 35 7.2 Funding 35 7.3 Hedging 35 7.4 Portfolio investment 36 7.5 Personal 36 7.6 Market making 36 7.7 Transaction exposure 36 7.8 Translation exposure 37 7.9 Economic exposure 37 7.10 Concluding remarks 37 8 Applications of Currency Options 39 9 Users of Currency Options 41 9.1 Variety of reasons 41 9.1.1 Example 1 42 9.1.2 Example 2 43 9.1.3 Example 3 43 9.2 Hedging vs speculation 44 Glossary of foreign exchange terms 45 PART II CURRENCY OPTIONS – THE ESSENTIALS 47 10 Definitions and Terminology 49 10.1 Call option 50 10.2 Put option 50 10.3 Parties and the risks involved 51 10.4 Currency option risk/reward perception 51 10.5 Currency or dollar call or put option? 52 10.6 Strike price and strike selection 52 10.7 Exercising options 53 10.8 American and European style options 53 10.9 In-, at- or out-of-the-money 55 10.10 The premium 57 10.11 Volatility 59 10.12 Break-even 60 11 The Currency Option Concept 61 12 The Currency Options Market 63 12.1 Exchange vs over-the-counter 63 12.2 Standardised Options 65 12.3 Customised options 66 12.4 Features of the listed market 67 12.5 Comparisons 69 12.6 Where is the market? 69 12.7 Concluding remarks 69 13 Option Pricing Theories 71 13.1 Basic properties 71 13.2 Theoretical valuation 72 13.3 Black-Scholes model 73 13.4 Examples of other models 74 13.5 Pricing without a computer model 76 13.6 Educated guess 76 13.7 The price of an option 76 13.8 Option premium profile 78 13.9 Time value and intrinsic value 78 13.10 Time to expiry 79 13.11 Volatility 79 13.12 Strike price and forward rates 82 13.13 Interest rates 82 13.14 American vs European 83 13.15 Concluding remarks 84 14 The Greeks 85 14.1 Delta 85 14.2 Gamma 88 14.3 Theta 90 14.4 Vega 92 14.5 Rho 92 14.6 Beta and omega 93 15 Payoff and Profit/Loss Diagrams 95 15.1 Payoff diagram 95 15.2 Profit diagram 95 15.3 The option writer 97 15.4 Put option 97 15.5 Put option writer 98 15.6 Basic option positions 98 15.7 Graph addition 100 15.8 Profit/loss profiles for ten popular option strategies 101 15.9 Concluding remarks 102 16 Basic Properties of Options 105 16.1 Option values 105 16.2 Put/call parity concept 106 16.3 Synthetic positions 108 17 Risk Reversals 111 17.1 Understanding risk reversals 111 17.2 Implications for traders 112 17.3 Implications for hedgers 113 17.4 Concluding remarks 114 18 Market Conventions 115 18.1 Option price 115 18.2 What rate to use? 116 18.3 Live price 116 18.4 Pricing terms 117 18.5 Premium conversions 117 18.6 Settlement 117 18.7 How is an option exercised? 118 18.8 Risks 118 18.9 Concluding remarks 119 Basic option glossary 121 PART III CURRENCY OPTION PRODUCTS 125 19 Vanilla Options 127 19.1 Long options 127 19.2 Short options 127 19.3 Straddle 128 19.4 Strangle 129 19.5 Cylinder 130 19.6 Collar 131 19.7 Participating forward 131 19.8 Ratio forward 132 19.9 Added extras to vanilla options 133 20 Common Option Strategies 135 20.1 Directional options 137 20.2 Precision options 139 20.3 Locked trade options 144 21 Exotic Options 145 21.1 Barriers 145 21.2 Average rates 148 21.3 Lookback and ladder 149 21.4 Chooser 152 21.5 Digital (binary) 153 21.6 Baskets 154 21.7 Compound 156 21.8 Variable notional 157 21.9 Multi-factor 158 22 Structured Currency Options 159 22.1 Trigger forward 159 22.2 Double trigger forward 160 22.3 At maturity trigger forward 161 22.4 Forward extra 161 22.5 Weekly reset forward 162 22.6 Range binary 163 22.7 Contingent premium 163 22.8 Wall 164 22.9 Corridor 165 23 Case Studies 167 23.1 Hedging 167 23.2 Trading 169 23.3 Investment 170 23.4 Bid to offer exposure 171 23.5 Concluding remarks 173 24 Option Hedge Matrix 175 Exotic currency option glossary 187 25 Concluding Remarks 193 Index 195

About the Author :
SHANI SHAMAH has spent over twenty years in the financial market. Her previous book, A Foreign Exchange Primer, is proving to be a great success.