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FX Options and Risk Management

Day One

The Foreign Exchange Spot Market

  • Mechanism of FX spot trades
  • Market conventions for quotation and settlement
  • Currency triangles and the chain rule
  • Bid-offer spreads, liquidity and depth
  • The spot market ecosystem, electronic trading platforms
  • Managed and restricted currencies: pegged exchange rates, onshore/offshore markets

FX Forwards and Futures

  • FX market risk and the concept of hedging
  • Forward contracts: strike calculation, settlement and market quotation conventions
  • Mathematical formulae for the fair forward rate, with worked examples
  • Electronic trading platforms
  • How futures contracts work
  • Trading on an exchange, margin treatment
  • Payoff scenario analysis

Workshop: Manage FX Risk using a Forward Contract – Work through the lifecycle of an FX forward contract: calculate the fair forward rate; set the strike; specify the OTC contract; re-value your position through its life; settle the contract with the counterparty

Currency Swaps

  • Managing FX risk over extended time periods
  • The structure of a currency swap and its use as a hedging/re-structuring tool
  • Relationship with bonds and FX forwards

Introduction to Vanilla Options

  • The concept of optionality
  • Specification and mechanism of vanilla options

Workshop: Manage FX Risk using a Dual-Currency Deposit (DCD) – Explore the FX risk in a deposit under multiple currency views. Demonstrate how vanilla options can be used to manage the risk. Structure a Dual-Currency Deposit. Analyze different outcome scenarios


Day Two

Properties of Vanilla Options

  • Put-Call parity and other risk relationships
  • Properties of vanilla options: premium, P&L, time value, intrinsic value, moneyness
  • Market conventions for quotation – the 6 quotation styles and how to convert between them
  • Variation of premium with market and contract parameters
  • Electronic trading platforms

Vanilla Options Structures

  • Spreads, straddles, strangles, risk reversals, and other structures
  • The risk characteristics of different structures and their relative merits for hedging or speculation
  • Scenario analysis

Workshop: Manage FX Risk using a Risk Reversal (I) – Assess an FX risk position. Devise and explain a vanilla structure hedge. Specify the parameters of the structure. Perform scenario analysis

FX Exotic Options – Variations on the Vanilla Option

  • Cash settlement
  • Late delivery
  • European digitals
  • Quanto and self-quanto options

FX Exotic Options – Barrier Options

  • Barrier-contingent vanilla options
  • Knock-Out types, Knock-In types, KIKOs
  • Barrier-contingent payments and forwards

Workshop: Manage FX Risk using a Risk Reversal (II) – Assess an FX risk position. Consider various barrier options as hedges. Choose the most suitable option type. Specify the terms of the contract. Calculate the size of hedge needed. Perform scenario analysis


Day Three

The Black-Scholes Model

  • The process model for FX spot price
  • Overview of the derivation and solution of the valuation PDE
  • Pricing formulae for vanilla options

Black-Scholes Risk Management and the Greeks

  • The Greeks: delta, gamma, vega, volgamma, vanna, rho, theta
  • The special significance of delta and its different flavours
  • Local vs. non-local risk

Workshop: Design a presentation to a treasury department explaining how the use of various derivatives will reduce its risk. Calculate payoff and Greek profiles. Compare unhedged and hedged risks. Optimize derivative parameters

Smile Pricing

  • Implied volatility smiles, term structures and surfaces
  • Delta quotation and the conventions of the FX vanilla option market
  • Volatility interpolation using implied volatility models
  • Smile pricing models: local volatility, Heston, SABR, mixed local/stochastic volatility
  • Theoretical value and skew to TV

Smile Risk Management

  • Managing term structure risk and volatility surface risk
  • Sticky strike vs. sticky delta

Volatility Products

  • Volatility swaps and variance swaps
  • Forward volatility agreements

Multi-Currency Products

  • FX basket products, quanto feature
  • Black-Scholes treatment: volatility triangles and correlations
  • Dealing with multiple volatility smiles: correlation skew

Workshop: Consider a multi-currency cash flow risk. Structure a quanto basket option. Analyze the risk under different scenarios



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