Disclaimer xi
1 Introduction 1
1.1 The forward foreign exchange market 1
1.2 The currency options market 1
1.3 The alternatives to currency options 2
1.4 The users 2
1.5 Whose domain? 2
PART I MARKET OVERVIEW 3
2 The Foreign Exchange Market 5
2.1 Twenty-four-hour global market 5
2.2 Value terms 5
2.3 Coffee houses 6
2.4 Spot and forward market 6
2.5 Alternative markets 7
2.6 Currency options 7
2.7 Concluding remarks 8
3 A Brief History of the Market 9
3.1 The barter system 9
3.2 The introduction of coinage 9
3.3 The expanding British Empire 10
3.4 The gold standard 10
3.5 The Bretton Woods system 11
3.6 The International Monetary Fund and the World Bank 11
3.7 The dollar rules OK 12
3.8 Special drawing rights 12
3.9 A dollar problem 13
3.10 The Smithsonian agreement 13
3.11 The snake 13
3.12 The dirty float 13

3.13 The European Monetary System 14
3.14 The Exchange Rate Mechanism 14
3.15 The European Currency Unit 15
3.16 The Maastricht Treaty 15
3.17 The Treaty of Rome 15
3.18 Economic reform 16
3.19 A common monetary policy 16
1.20 A single currency 16
3.21 Currency options 18
3.22 Concluding remarks 20
4 Market Overview 21
4.1 Global market 21
4.2 No physical trading floor 21
4.3 A “perfect” market 21
4.4 The main instruments 22
4.5 Comparisons of options with spot and forwards 23
4.6 The dollar’s role 24
4.7 Widely traded currency pairs 24
4.8 Concluding remarks 25
5 Major Participants 27
5.1 Governments 27
5.2 Banks 27
5.3 Brokering houses 29
5.4 International Monetary Market 29
5.5 Money managers 29
5.6 Corporations 29
5.7 Retail clients 29
5.8 Others 30
5.9 Speculators 30
5.10 Trade and financial flows 30
6 Roles Played 33
6.1 Market makers 33
6.2 Price takers 33
6.3 A number of roles 33
6.4 A number of roles – options 34
6.5 Concluding remarks 34
7 Purposes 35
7.1 Commercial transactions 35
7.2 Funding 35
7.3 Hedging 35
7.4 Portfolio investment 36
7.5 Personal 36
7.6 Market making 36

7.7 Transaction exposure 36
7.8 Translation exposure 37
7.9 Economic exposure 37
7.10 Concluding remarks 37
8 Applications of Currency Options 39
9 Users of Currency Options 41
9.1 Variety of reasons 41
9.1.1 Example 1 42
9.1.2 Example 2 43
9.1.3 Example 3 43
9.2 Hedging vs speculation 44
Glossary of foreign exchange terms 45
PART II CURRENCY OPTIONS – THE ESSENTIALS 47
10 Definitions and Terminology 49
10.1 Call option 50
10.2 Put option 50
10.3 Parties and the risks involved 51
10.4 Currency option risk/reward perception 51
10.5 Currency or dollar call or put option? 52
10.6 Strike price and strike selection 52
10.7 Exercising options 53
10.8 American and European style options 53
10.9 In-, at- or out-of-the-money 55
10.10 The premium 57
10.11 Volatility 59
10.12 Break-even 60
11 The Currency Option Concept 61
12 The Currency Options Market 63
12.1 Exchange vs over-the-counter 63
12.2 Standardised Options 65
12.3 Customised options 66
12.4 Features of the listed market 67
12.5 Comparisons 69
12.6 Where is the market? 69
12.7 Concluding remarks 69
13 Option Pricing Theories 71
13.1 Basic properties 71
13.2 Theoretical valuation 72
13.3 Black-Scholes model 73

13.4 Examples of other models 74
13.5 Pricing without a computer model 76
13.6 Educated guess 76
13.7 The price of an option 76
13.8 Option premium profile 78
13.9 Time value and intrinsic value 78
13.10 Time to expiry 79
13.11 Volatility 79
13.12 Strike price and forward rates 82
13.13 Interest rates 82
13.14 American vs European 83
13.15 Concluding remarks 84
14 The Greeks 85
14.1 Delta 85
14.2 Gamma 88
14.3 Theta 90
14.4 Vega 92
14.5 Rho 92
14.6 Beta and omega 93
15 Payoff and Profit/Loss Diagrams 95
15.1 Payoff diagram 95
15.2 Profit diagram 95
15.3 The option writer 97
15.4 Put option 97
15.5 Put option writer 98
15.6 Basic option positions 98
15.7 Graph addition 100
15.8 Profit/loss profiles for ten popular option strategies 101
15.9 Concluding remarks 102
16 Basic Properties of Options 105
16.1 Option values 105
16.2 Put/call parity concept 106
16.3 Synthetic positions 108
17 Risk Reversals 111
17.1 Understanding risk reversals 111
17.2 Implications for traders 112
17.3 Implications for hedgers 113
17.4 Concluding remarks 114
18 Market Conventions 115
18.1 Option price 115
18.2 What rate to use? 116

18.3 Live price 116
18.4 Pricing terms 117
18.5 Premium conversions 117
18.6 Settlement 117
18.7 How is an option exercised? 118
18.8 Risks 118
18.9 Concluding remarks 119
Basic option glossary 121
PART III CURRENCY OPTION PRODUCTS 125
19 Vanilla Options 127
19.1 Long options 127
19.2 Short options 127
19.3 Straddle 128
19.4 Strangle 129
19.5 Cylinder 130
19.6 Collar 131
19.7 Participating forward 131
19.8 Ratio forward 132
19.9 Added extras to vanilla options 133
20 Common Option Strategies 135
20.1 Directional options 137
20.2 Precision options 139
20.3 Locked trade options 144
21 Exotic Options 145
21.1 Barriers 145
21.2 Average rates 148
21.3 Lookback and ladder 149
21.4 Chooser 152
21.5 Digital (binary) 153
21.6 Baskets 154
21.7 Compound 156
21.8 Variable notional 157
21.9 Multi-factor 158
22 Structured Currency Options 159
22.1 Trigger forward 159
22.2 Double trigger forward 160
22.3 At maturity trigger forward 161
22.4 Forward extra 161
22.5 Weekly reset forward 162
22.6 Range binary 163

22.7 Contingent premium 163
22.8 Wall 164
22.9 Corridor 165
23 Case Studies 167
23.1 Hedging 167
23.2 Trading 169
23.3 Investment 170
23.4 Bid to offer exposure 171
23.5 Concluding remarks 173
24 Option Hedge Matrix 175
Exotic currency option glossary 187
25 Concluding Remarks 193
Index 195