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Options on Foreign Exchange, Third Edition

Book Description

A comprehensive guide to the world's largest financial market

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 surface

  • Includes expanded coverage of the currency crises and capital controls, electronic trading, forward contracts, exotic options, and more

  • Employs real-world terminology so you can a firm understanding of this dynamic marketplace

The 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.

Table of Contents

  1. Cover
  2. Series
  3. Title Page
  4. Copyright
  5. Dedication
  6. Preface
  7. WHAT'S NEW TO THIS EDITION
  8. BEFORE YOU BEGIN
  9. Acknowledgments
  10. Chapter 1: Foreign Exchange Basics
    1. THE FOREIGN EXCHANGE MARKET
    2. THE INTERNATIONAL MONETARY SYSTEM
    3. SPOT FOREIGN EXCHANGE AND MARKET CONVENTIONS
    4. FOREIGN EXCHANGE DEALING
    5. INTEREST PARITY AND FORWARD FOREIGN EXCHANGE
    6. DEPARTURES FROM COVERED INTEREST PARITY IN 2007–2008
  11. Chapter 2: Trading Currency Options
    1. THE INTERBANK CURRENCY OPTION MARKET
    2. OPTION BASICS
    3. LISTED OPTIONS ON ACTUAL FOREIGN CURRENCY
    4. CURRENCY FUTURES CONTRACTS
    5. LISTED CURRENCY FUTURES OPTIONS
  12. Chapter 3: Valuation of European Currency Options
    1. ARBITRAGE THEOREMS
    2. PUT-CALL PARITY FOR EUROPEAN CURRENCY OPTIONS
    3. THE BLACK-SCHOLES-MERTON MODEL
    4. HOW CURRENCY OPTIONS TRADE IN THE INTERBANK MARKET
    5. REFLECTIONS ON THE CONTRIBUTION OF BLACK, SCHOLES, AND MERTON
  13. Chapter 4: European Currency Option Analytics
    1. BASE-CASE ANALYSIS
    2. THE “GREEKS”
    3. SPECIAL PROPERTIES OF AT-THE-MONEY FORWARD OPTIONS
    4. DIRECTIONAL TRADING WITH CURRENCY OPTIONS
    5. HEDGING WITH CURRENCY OPTIONS
    6. APPENDIX 4.1 DERIVATION OF THE BSM DELTAS
  14. Chapter 5: Volatility
    1. ALTERNATIVE MEANINGS OF VOLATILITY
    2. SOME VOLATILITY HISTORY
    3. CONSTRUCTION OF THE VOLATILITY SURFACE
    4. THE VANNA-VOLGA METHOD
    5. THE STICKY DELTA RULE
    6. RISK-NEUTRAL DENSITIES
    7. DEALING IN CURRENCY OPTIONS
    8. TRADING VOLATILITY
    9. MIXING DIRECTIONAL AND VOLATILITY TRADING
    10. APPENDIX 5.1 VANNA-VOLGA APPROXIMATIONS
  15. Chapter 6: American Exercise Currency Options
    1. ARBITRAGE CONDITIONS
    2. PUT-CALL PARITY FOR AMERICAN CURRENCY OPTIONS
    3. THE GENERAL THEORY OF AMERICAN CURRENCY OPTION PRICING
    4. THE ECONOMICS OF EARLY EXERCISE
    5. THE BINOMIAL MODEL
    6. THE BINOMIAL MODEL FOR EUROPEAN CURRENCY OPTIONS
    7. AMERICAN CURRENCY OPTIONS BY APPROXIMATION
    8. FINITE DIFFERENCES METHODS
  16. Chapter 7: Currency Futures Options
    1. CURRENCY FUTURES AND THEIR RELATIONSHIP TO SPOT AND FORWARD EXCHANGE RATES
    2. ARBITRAGE AND PARITY THEOREMS FOR CURRENCY FUTURES OPTIONS
    3. BLACK'S MODEL FOR EUROPEAN CURRENCY FUTURES OPTIONS
    4. THE VALUATION OF AMERICAN CURRENCY FUTURES OPTIONS
    5. THE QUADRATIC APPROXIMATION MODEL FOR FUTURES OPTIONS
  17. Chapter 8: Barrier and Binary Currency Options
    1. SINGLE BARRIER CURRENCY OPTIONS
    2. DOUBLE BARRIER KNOCK-OUT CURRENCY OPTIONS
    3. BINARY CURRENCY OPTIONS
    4. CONTINGENT PREMIUM CURRENCY OPTIONS
    5. APPLYING VANNA-VOLGA TO BARRIER AND BINARY OPTIONS
    6. WHAT THE FORMULAS DON'T REVEAL
  18. Chapter 9: Advanced Option Models
    1. STOCHASTIC VOLATILITY MODELS
    2. THE MIXED JUMP-DIFFUSION PROCESS MODEL
    3. LOCAL VOLATILITY MODELS
    4. STOCHASTIC LOCAL VOLATILITY
    5. STATIC REPLICATION OF BARRIER OPTIONS
    6. APPENDIX 9.1: EQUATIONS FOR THE HESTON MODEL
  19. Chapter 10: Non-Barrier Exotic Currency Options
    1. AVERAGE RATE CURRENCY OPTIONS
    2. COMPOUND CURRENCY OPTIONS
    3. BASKET OPTIONS
    4. QUANTOS OPTIONS
    5. COMMENTS ON HEDGING WITH NON-BARRIER CURRENCY OPTIONS
    6. APPENDIX 10.1 MONTE CARLO SIMULATION FOR ARITHMETIC MEAN AVERAGE OPTIONS
  20. Bibliography
  21. Index