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FX Option Performance: an analysis of the value delivered by FX options since the start of the market + Data Set




FX Option Performance: an analysis of the value delivered by FX options since the start of the market + Data Set

Jessica James, Jonathan Fullwood, Peter Billington

ISBN: 978-1-119-13550-0 May 2015 264 Pages

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Historical FX options data gives you the whole story for more informed strategy

FX Options Performance is a practical handbook for successfully navigating the FX options market. Beginning with a quick overview of the market, its participants, and its products, the book then travels back in time to examine the historical payoffs to the most popular and liquidly traded option types. You'll learn which options have been consistently overvalued or undervalued, and which commonly used structures are not necessarily good value at all. The discussion also covers emerging markets and reveals truly surprising facts you won't find anywhere else — including corporate hedging strategies that reveal, in many cases, significant potential savings. Historically, some option selling strategies have been profitable, though high risk, but this book delves into the historical data to show which strategies have actually worked in the past, why they worked, and how you can mitigate risks. The companion website provides all of the detailed data in the book — over 100 tables — as easily downloadable data sets, so you can quickly start replicating these calculations and see for yourself how some simple estimates reveal historical anomalies.

FX options are enormously popular, but there are many fundamental facts about the market that are generally unknown. This book brings everything out into the light, and provides the hard data you've been looking for.

  • Learn why supposedly "cheap" out of the money options aren't always worth it
  • Understand why "more sophisticated" doesn't necessarily mean "better"
  • Reduce FX risk in the most efficient way – and it is not always a forward contract
  • Understand historical options trading strategies that have actually worked, and use them to design strategies for the future

The FX options market offers tremendous opportunity, but requires complete, in-depth understanding. Written by experienced quants and traders, FX Options Performance goes beyond theory to give you the numbers that show how much these contracts have really made or lost.

About the Authors xi

Data Set xii

CHAPTER 1 Introduction 1

1.1 Why Read This Book? 1

1.2 This Book 3

1.3 What Is an FX Option? 3

1.4 Market Participants 5

1.4.1 How Hedgers Can Use This Information 6

1.4.2 How Investors Can Use This Information 7

1.5 History and Size of the FX Option Market 9

1.6 The FX Option Trading Day 14

1.7 Summary 14

References 14

CHAPTER 2 The FX Option Market: How Options Are Traded and What That Implies for Option Value 17

2.1 Introduction 17

2.2 The Basics of Option Pricing 18

2.2.1 The Black-Scholes-Merton Model 18

2.2.2 The Impact of Volatility 20

2.2.3 The Impact of Rate Differentials 21

2.3 How Options Are Traded 22

2.3.1 Two Views of Volatility 23

2.3.2 Static Trading 24

2.3.3 Dynamic Trading 24

2.4 A More Detailed Discussion of Option Trading 26

2.4.1 The Greeks 26

2.5 Summary 31

References 31

CHAPTER 3 It Is All About the Data 33

3.1 Introduction 33

3.2 The Goal: To Price Lots of Options! 34

3.3 Defining a Universe of Currencies 34

3.4 The Data 37

3.4.1 Pricing Model Data Requirements 38

3.4.2 Sourcing the Data 39

3.4.3 Calculation Frequency 40

3.4.4 Currency of Option Notional Amount 41

3.4.5 Spot Market Value 42

3.5 Limitations 43

3.6 Summary 45

References 45

CHAPTER 4 At-the-Money-Forward (ATMF) Options 47

4.1 What Are ATMF Options? 47

4.1.1 How Are ATMF Options Used and Traded? 47

4.1.2 What Is the ‘Fair’ Price for an ATMF Option? 48

4.2 How Might Mispricings Arise? 50

4.2.1 Can the Forward Rate Be on Average Wrong? 51

4.2.2 Can the Implied Volatility Be on Average Wrong? 52

4.2.3 Simple Example with USDJPY 53

4.3 Results for Straddles for All Currency Pairs 55

4.3.1 Discussion of Results for Straddles 57

4.3.2 A Breakdown of the Results by Currency Pair 62

4.3.3 Drilling Down to Different Time Periods 62

4.3.4 Comparison of Put and Call Options 64

4.4 Have We Found a Trading Strategy? 75

4.5 Summary of Results 76

References 76

CHAPTER 5 Out-of-the-Money (OTM) Options: Do Supposedly ‘Cheap’ OTM Options Offer Good Value? 77

5.1 Introduction 77

5.2 Price versus Value 78

5.3 The Implied Volatility Surface 79

5.4 Why Do Volatility Surfaces Look Like They Do? 80

5.4.1 Equity Indices 80

5.4.2 Foreign Exchange Markets 83

5.5 Parameterising the Volatility Smile 84

5.6 Measuring Relative Value in ATMF and OTM Foreign Exchange Options 88

5.6.1 The Analysis 89

5.6.2 Option Premium 90

5.6.3 Option Payoff 90

5.6.4 Payoff-to-Premium Ratios 90

5.6.5 Discussion 95

5.6.6 Alternative Measures of OTM Option Worth 96

5.7 Summary 97

Reference 97

CHAPTER 6 G10 vs EM Currency Pairs 99

6.1 Why Consider EM and G10 Options Separately? 99

6.2 How Would EM FX Options Be Used? 99

6.3 Straddle Results 100

6.3.1 Comparison of ATMF Put and Call Options 103

6.3.2 Comparison of OTM Put and Call Options 106

6.3.3 The Effect of Tenor 111

6.4 Hedging with Forwards vs Hedging with Options 113

6.5 Summary of Results 120

CHAPTER 7 Trading Strategies 123

7.1 Introduction 123

7.2 History of the Carry Trade 123

7.3 Theory 124

7.4 G10 Carry Trade Results 125

7.5 EM Carry Trade Results 130

7.6 What Is Going On? 131

7.7 Option Trading Strategies – Buying Puts 132

7.8 Option Trading Strategies – Selling Calls 136

7.9 Option Trading Strategies – Trading Carry with Options 140

7.9.1 Premium and Payoff vs MTM Calculations 144

7.10 Summary of Results 146

References 147

CHAPTER 8 Summary 149

8.1 A Call to Arms 149

8.2 Summary of Results from This Book 150

8.3 Building up a Picture 151

8.3.1 What Does This Mean in Practice? 155

8.4 Final Word 156

Appendix 157

Glossary 241

Index 247 Data Set Access Code / Registration Site