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More About This Title Options on Foreign Exchange, Third Edition
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Foreign exchange is the world's largest financial market and continues to grow at a rapid pace. As economies intertwine and currencies fluctuate there is hardly a corporate entity that doesn't need to use options on foreign exchange to hedge risk or increase returns. Moreover, currency options, both vanilla and exotic, are part of standard toolkit of professional portfolio managers and hedge funds.
Written by a practitioner with real-world experience in this field, the Third Edition of Options on Foreign Exchange opens with a substantive discussion of the spot and forward foreign exchange market and the mechanics of trading currency options. The Black-Scholes-Merton option-pricing model as applied to currency options is also covered, along with an examination of currency futures options. Throughout the book, author David DeRosa addresses the essential elements of this discipline and prepares you for the various challenges you could face.
Updates new developments in the foreign exchange markets, particularly regarding the volatility surfaceIncludes expanded coverage of the currency crises and capital controls, electronic trading, forward contracts, exotic options, and moreEmploys real-world terminology so you can a firm understanding of this dynamic marketplaceThe only way to truly succeed in today's foreign exchange market is by becoming more familiar with currency options. The Third Edition of Options on Foreign Exchange will help you achieve this goal and put you in better position to make more profitable decisions in this arena.
English
English
What's New to This Edition xii
Before You Begin xii
Acknowledgments xiii
CHAPTER 1: Foreign Exchange Basics 1
The Foreign Exchange Market 1
The International Monetary System 6
Spot Foreign Exchange and Market Conventions 11
Foreign Exchange Dealing 14
Interest Parity and Forward Foreign Exchange 21
Departures from Covered Interest Parity in 2007–2008 26
CHAPTER 2: Trading Currency Options 29
The Interbank Currency Option Market 29
Option Basics 31
Listed Options on Actual Foreign Currency 38
Currency Futures Contracts 40
Listed Currency Futures Options 44
CHAPTER 3: Valuation of European Currency Options 47
Arbitrage Theorems 48
Put-Call Parity for European Currency Options 50
The Black-Scholes-Merton Model 52
How Currency Options Trade in the Interbank Market 60
Reflections on the Contribution of Black, Scholes, and Merton 62
CHAPTER 4: European Currency Option Analytics 65
Base-Case Analysis 65
The "Greeks" 66
Special Properties of At-the-Money Forward Options 77
Directional Trading with Currency Options 79
Hedging with Currency Options 86
Appendix 4.1 Derivation of the BSM Deltas 88
CHAPTER 5: Volatility 91
Alternative Meanings of Volatility 91
Some Volatility History 99
Construction of the Volatility Surface 113
The Vanna-Volga Method 115
The Sticky Delta Rule 118
Risk-Neutral Densities 118
Dealing in Currency Options 119
Trading Volatility 121
Mixing Directional and Volatility Trading 124
Appendix 5.1 Vanna-Volga Approximations 125
CHAPTER 6: American Exercise Currency Options 127
Arbitrage Conditions 127
Put-Call Parity for American Currency Options 128
The General Theory of American Currency Option Pricing 131
The Economics of Early Exercise 132
The Binomial Model 136
The Binomial Model for European Currency Options 143
American Currency Options by Approximation 144
Finite Differences Methods 149
CHAPTER 7: Currency Futures Options 159
Currency Futures and Their Relationship to Spot and Forward Exchange Rates 159
Arbitrage and Parity Theorems for Currency Futures Options 167
Black's Model for European Currency Futures Options 174
The Valuation of American Currency Futures Options 178
The Quadratic Approximation Model for Futures Options 180
CHAPTER 8: Barrier and Binary Currency Options 183
Single Barrier Currency Options 185
Double Barrier Knock-Out Currency Options 193
Binary Currency Options 197
Contingent Premium Currency Options 203
Applying Vanna-Volga to Barrier and Binary Options 204
What the Formulas Don't Reveal 205
CHAPTER 9: Advanced Option Models 207
Stochastic Volatility Models 208
The Mixed Jump-Diffusion Process Model 211
Local Volatility Models 213
Stochastic Local Volatility 214
Static Replication of Barrier Options 215
Appendix 9.1: Equations for the Heston Model 231
CHAPTER 10: Non-Barrier Exotic Currency Options 233
Average Rate Currency Options 233
Compound Currency Options 237
Basket Options 241
Quantos Options 242
Comments on Hedging with Non-Barrier Currency Options 250
Appendix 10.1 Monte Carlo Simulation for Arithmetic Mean Average Options 250
Bibliography 253
Index 263
