FX Options and Structured Products (eBook)

Uwe Wystup (Autor)

eBook Download: EPUB

2017 | 2. Auflage
John Wiley & Sons (Verlag)
978-1-118-47113-5 (ISBN)

Infos

An academic, yet practical approach to the latest FX market developments

FX Options and Structured Products provides new insights into the FX Options market post-crisis, straddling the realms of both academics and practitioners. Products are explained in a simple case study format, with clear examples of all FX options, common structures, and tailor-made solutions. This new second edition contains updated real-world deals complete with explanatory background information, plus new information on yield curve construction, spreading, litigation, and new products and trade ideas. Interviews have been extended to provide additional in-depth information, and new coverage on the latest trading technology guides readers toward cutting edge tools and services.

Foreign Exchange Options and Structured Products are typically traded over the counter, and market participants need to fully understand the products to work with them effectively. FX Options and Structured Products is a complete reference, helping practitioners understand the products, how they're used, and how they're priced, and the risk management, hedging, regulatory, and accounting issues involved.

• Understand spreads in the interest rate market, and how they affect valuation of FX options
• Learn why yield curve construction is a crucial ingredient for pricing, and examine the vanna-volga approach
• Explore recent advances in software for trading and platform structuring
• Review the various products including accumulators, kikos, auto-callables, and more

This authoritative reference also provides expert guidance toward practical application, helping readers structure their own solutions with new ideas and understanding. Knowing how and why particular products are applied in different situations helps practitioners build alternative solutions to client problems. For complete mastery of the FX market, FX Options and Structured Products is a valuable resource and a thorough guide.

UWE WYSTUP is the founder and managing director of Math-Finance AG, a consulting and software company specializing in quantitative finance, implementation of derivatives models, valuation and validation services. During his career, he worked as a financial engineer, structurer and consultant in FX options trading teams for such banks as Commerzbank, Deutsche Bank, Citibank, UBS and Sal. Oppenheim jr. & Cie. An internationally known FX options expert in academia and practice, he lectures on financial engineering as an honorary professor at Frankfurt School of Finance & Management and a professor of financial option price modeling and foreign exchange derivatives at Antwerp University, in addition to giving seminars all over the world. He coedited (with Jürgen Hakala) the industry standard, Foreign Exchange Risk.

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Advanced Guidance to Excelling in the FX Market Once you have a textbook understanding of money market and foreign exchange products, turn to FX Options and Structured Products, Second Edition, for the beyond-vanilla options strategies and traded deals proven superior in today s post-credit crisis trading environment. With the thoroughness and balance of theory and practice only Uwe Wystup can deliver, this fully revised edition offers authoritative solutions for the real world in an easy-to-access format. See how specific products actually work through detailed case studies featuring clear examples of FX options, common structures and custom solutions. This complete resource is both a wellspring of ideas and a hands-on guide to structuring and executing your own strategies. Distinguish yourself with a valued skillset by: Working through practical and thought-provoking challenges in more than six dozen exercises, all with complete solutions in a companion volume Gaining a working knowledge of the latest, most popular products, including accumulators, kikos, target forwards and more Getting close to the everyday realities of the FX derivatives market through new, illuminating case studies for corporates, municipalities and private banking FX Options and Structured Products, Second Edition is your go-to road map to the exotic options in FX derivatives.

Inhalt

0 Preface 17

0.1 Scope of this Book 17

0.2 The Readership 18

0.3 About the Author 19

0.4 Acknowledgments 19

1 Foreign Exchange Derivatives 21

1.1 Literature Review 21

1.2 A Journey through the History of Options 21

1.3 Currency Options 23

1.4 Technical Issues for Vanilla Options 24

1.5 Volatility 55

1.6 Basic Strategies Containing Vanilla Options 83

1.7 First Generation Exotics 104

1.8 Second Generation Exotics (Single Currency Pair) 192

1.9 Second Generation Exotics (Multiple Currency Pairs) 217

2 Structured Products 237

2.1 Forward Transactions 237

2.2 Target Forwards 291

2.3 Series of Strategies 320

2.4 Deposits, Loans, Bonds and Certificates 324

2.5 Interest Rate and Cross Currency Swaps 344

2.6 Participation Notes 376

2.7 Hybrid FX Products 381

2.8 Treasury Case Studies 389

3 Hedge Accounting 403

3.1 Hedge Accounting under IAS 39 403

3.2 Hedge Accounting under IFRS 9 475

4 Foreign Exchange Markets 483

4.1 Vanna-Volga Pricing 483

4.2 Bid-Ask Spreads 495

4.3 Systems and Software 498

4.4 Trading and Sales 500

4.5 Currency Pairs 506

4.6 Things to Remember 510

4.7 Glossary 510

Textauszug

CHAPTER 1
Foreign Exchange Derivatives

The FX derivatives market consists of FX swaps, FX forwards, FX or currency options, and other more general derivatives. FX structured products are either standardized or tailor‐made linear combinations of simple FX derivatives including both vanilla and exotic options, or more general structured derivatives that cannot be decomposed into simple building blocks. The market for structured products is restricted to the market of the necessary ingredients. Hence, typically there are mostly structured products traded in the currency pairs that can be formed between USD, JPY, EUR, CHF, GBP, CAD and AUD. In this chapter we start with a brief history of options, followed by a technical section on vanilla options and volatility, and deal with commonly used linear combinations of vanilla options. Then we will illustrate the most important ingredients for FX structured products: the first and second generation exotics.

1.1 LITERATURE REVIEW

While there are tons of books on options and derivatives in general, very few are dedicated specifically to FX options. After the 2008 financial crisis, more such books appeared. Shamah [118] is a good source to learn about FX markets with a focus on market conventions, spot, forward, and swap contracts, and vanilla options. For pricing and modeling of exotic FX options I (obviously) suggest Hakala and Wystup's Foreign Exchange Risk [65] or its translation into Mandarin [68] as useful companions to this book. One of the first books dedicated to Mathematical Models for Foreign Exchange is by Lipton [92]. In 2010, Iain Clark published Foreign Exchange Option Pricing [28], and Antonio Castagna one on FX Options and Smile Risk [25], which both make a valuable contribution to the FX derivatives literature. A classic is Alan Hicks's Managing Currency Risk Using Foreign Exchange Options [76]. It provides a good overview of FX options mainly from the corporate's point of view. An introductory book on Options on Foreign Exchange is by DeRosa [38]. The Handbook of Exchange Rates [82] provides a comprehensive compilation of articles on the FX market structure, products, policies, and economic models.

1.2 A JOURNEY THROUGH THE HISTORY OF OPTIONS

The very first options and futures were traded in ancient Greece, when olives were sold before they had reached ripeness. Thereafter the market evolved in the following way.

• 16th century Ever since the 15th century, tulips, which were desired for their exotic appearance, were grown in Turkey. The head of the royal medical gardens in Vienna, Austria, was the first to cultivate those Turkish tulips successfully in Europe. When he fled to Holland because of religious persecution, he took the bulbs along. As the new head of the botanical gardens of Leiden, Netherlands, he cultivated several new strains. It was from these gardens that avaricious traders stole the bulbs to commercialize them, because tulips were a great status symbol.
• 17th century The first futures on tulips were traded in 1630. As of 1634, people could buy special tulip strains by the weight of their bulbs – the bulbs had the same value as gold. Along with the regular trading, speculators entered the market and the prices skyrocketed. A bulb of the strain, “Semper Octavian,” was worth two wagonloads of wheat, four loads of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads of wine, four barrels of beer, two barrels of butter, 1,000 pounds of cheese, one marriage bed with linen, and one sizable wagon. People left their families, sold all their belongings, and even borrowed money to become tulip traders. When in 1637 this supposedly risk‐free market crashed, traders as well as private individuals went bankrupt. The Dutch government prohibited speculative trading; the period became famous as Tulipmania.
• 18th century In 1728, the West India and Guinea Company, the monopolist in trading with the Caribbean Islands and the African coast, issued the first stock options. These were options on the purchase of the French island of Sainte‐Croix, on which sugar plantings were planned. The project was realized in 1733 and paper stocks were issued in 1734. Along with the stock, people purchased a relative share of the island and the valuables, as well as the privileges and the rights of the company.
• 19th century In 1848, 82 businessmen founded the Chicago Board of Trade (CBOT). Today it is the biggest and oldest futures market in the entire world. Most written documents were lost in the great fire of 1871; however, it is commonly believed that the first standardized futures were traded as of 1860. CBOT now trades several futures and forwards, not only treasury bonds but also options and gold. In 1870, the New York Cotton Exchange was founded. In 1880, the gold standard was introduced.
• 20th century
  • In 1914, the gold standard was abandoned because of the First World War.
  • In 1919, the Chicago Produce Exchange, in charge of trading agricultural products, was renamed the Chicago Mercantile Exchange. Today it is the most important futures market for the Eurodollar, foreign exchange, and livestock.
  • In 1944, the Bretton Woods System was implemented in an attempt to stabilize the currency system.
  • In 1970, the Bretton Woods System was abandoned for several reasons.
  • In 1971, the Smithsonian Agreement on fixed exchange rates was introduced.
  • In 1972, the International Monetary Market (IMM) traded futures on coins, currencies and precious metal.
  • In 1973, the CBOE (Chicago Board of Exchange) firstly traded call options; four years later it added put options. The Smithsonian Agreement was abandoned; the currencies followed managed floating.
  • In 1975, the CBOT sold the first interest rate future, the first future with no “real” underlying asset.
  • In 1978, the Dutch stock market traded the first standardized financial derivatives.
  • In 1979, the European Currency System was implemented, and the European Currency Unit (ECU) was introduced.
  • In 1991, the Maastricht Treaty on a common currency and economic policy in Europe was signed.
  • In 1999, the Euro was introduced, but the countries still used cash of their old currencies, while the exchange rates were kept fixed.
• 21st century In 2002, the Euro was introduced as new money in the form of cash.

FX forwards and options originate from the need of corporate treasury to hedge currency risk. This is the key to understanding FX options. Originally, FX options were not speculative products but hedging products. This is why they trade over the counter (OTC). They are tailored, i.e. cash flow matching currency risk hedging instruments for corporates. The way to think about an option is that a corporate treasurer in the EUR zone has income in USD and needs a hedge to sell the USD and to buy EUR for these USD. He would go long a forward or a EUR call option. At maturity he would exercise the option if it is in‐the‐money and receive EUR and pay USD. FX options are by default delivery settled. While FX derivatives were used later also as investment products or speculative instruments, the key to understanding FX options is corporate treasury.

1.3 CURRENCY OPTIONS

Let us start with a definition of a currency option:

Definition 1.3.1   A Currency Option Transaction means a transaction entitling the Buyer, upon Exercise, to purchase from the Seller at the Strike Price a specified quantity of Call Currency and to sell to the Seller at the Strike Price a specified quantity of Put Currency.

This is the definition taken from the 1998 FX and Currency Option Definitions published by the International Swaps and Derivatives Association (ISDA) in 1998 [77]. This definition was the result of a process of standardization of currency options in the industry and is now widely accepted. Note that the key feature of an option is that the holder has a right to exercise. The definition also demonstrates clearly that calls and puts are equivalent, i.e. a call on one currency is always a put on the other currency. The definition is designed for a treasurer, where an actual cash flow of two currencies is triggered upon exercise. The definition also shows that the terms derivative and option are not synonyms. Derivative is a much wider term for financial transactions that depend on an underlying traded instrument. Derivatives include forwards, swaps, options, and exotic options. But not any derivative is also an option. For a currency option there is always a holder, the buyer after buying the option, equipped with the right to exercise, and upon exercise a cash flow of two pre‐specified currencies is triggered. Anything outside this definition does not constitute a currency option. I highly recommend reading the 1998 ISDA definitions. The text uses legal language, but it does make all the terms around FX and currency options very clear and it is the benchmark in the industry. It covers only put and call options, options that are typically referred to as vanilla options, because they are the most common and simple products. The definition allows for different exercise styles: European for exercise permitted only at maturity, American for exercise permitted at any time between inception and maturity, as well as Bermudan for exercise permitted as finitely many pre‐specified points...

Produkt-Details

• Erscheint lt. Verlag: 30.6.2017
• Reihe/Serie: The Wiley Finance Series
• Reihe/Serie: Wiley Finance Series
• Reihe/Serie: Wiley Finance Series
• Sprache: englisch
• Themenwelt: Recht / Steuern ► Wirtschaftsrecht
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Finanzierung
• Schlagworte: basis spreads • Finance & Investments • Financial Engineering • Finanztechnik • Finanz- u. Anlagewesen • foreign exchange derivatives • foreign exchange exotics, FX market developments • foreign exchange pricing • Foreign Exchange Risk • FX market advances • Fx Options • FX Options and Structured Products 2nd Edition • FX options case studies • FX options hedging • FX options in litigation • FX options valuation • FX products • FX risk management • FX strategy • FX structuring • FX structuring platforms • FX technology • FX tools • FX trade ideas • fx trading • mathfinance.com • smile risk • tenor spreads • Uwe Wystup • vanna-volga approach • yield curve construction
• ISBN-10: 1-118-47113-X / 111847113X
• ISBN-13: 978-1-118-47113-5 / 9781118471135