FX Exotic Options
Day One
Digital and Touch Contracts
Digital Contract paying domestic or foreign currency
Relationship between digital and vanilla options
Corridors and range accruals
Exact pricing of foreign- and domestic currency paying digitals
Windmill effect: impact of skew on digital price
Exact pricing of European barrier options
Semi-static hedging argument for one-touch (OT) contracts
The importance of forward skew
First-Generation Exotics and Valuation with Smile
ISDA 2005 Barrier Options Supplement
Pricing of touch contracts and barrier options in the Black-Scholes model
Workshop: hedging a knock-out (KO) with a risk reversal; building your own semi-static hedging tool, discuss forward volatility risk
Reverse knock-out options: European vs. American, monitoring, legal issues, barrier events
Pricing of reverse knock-out (RKO) barrier options
Hedging of RKOs, dealing with Greeks, barrier moving and bending, short-selling constraints
Impact of barrier option hedging on the spot
The pedigree of barrier and touch options
Workshop and discussion: how to construct the universe of barrier and touch options from key building blocks: vanilla and one-touch
Fluffy barrier options, step barrier options, occupation-time derivatives
Double barrier options and their Greeks
Parisian, Parasian, forward-start barriers, Two-Touch, James-Bond range
Knock-in-knock-out (KIKO) options, Transatlantic barriers, KOAMKIEU
Window barrier options
DNT / DKO relationship, RKO replication with KO and OT
Residual risk and limitations. static, semi-static and dynamic hedging approaches
Fixings, sources, monitoring, fixing governance
Traders’ approach to barrier option risk management / vanna-volga pricing
Second order Greeks and their relevance for the options trading book: vanna, volga
How higher order Greeks influence the price
Cost of hedging vanna with Risk Reversals
Cost of hedging volga with Butterflies
Survival probabilities, various approaches and their pros and cons
Case study: one-touch, one-touch moustache
Discussion of weaknesses and traps
Consistency analysis
Mixing super-replication and vanna-volga
Vanna-volga Greeks
Volunga / Vanunga / Aega / Rega / Sega / Bufga / Revga
Day Two
Overview of Pricing Models for Foreign Exchange Derivatives
Many pricing models are used for FX exotics, most popularly vanna-volga and stochastic-local volatility models. We provide an overview of common approaches in the market and show how some models overprice, and others underprice several exotic derivatives contracts as well as its implication on risk management.
Local volatility models (LV), pros and cons and where they fail
Stochastic volatility models (SV), pros and cons and where they fail
The mixture approach: stochastic-local volatility (SLV)
Mixed local volatility (MLV)
Advantages of a consistent SLV approach compared to vanna-volga
Common market practice
More Exotics
Compound and Instalment Options, Forward-volatility-agreements (FVA)
Power options
Forward-start options
Asian options: options on the geometric, arithmetic and harmonic mean
Contingent payment contracts: Pay-later
Quanto Options: Case Study: EUR-USD-XAU
Self-Quant Options: Case Study: Inverse DCI
Time options / flexible forwards
Tender-linked forwards
Variance and Volatility Swaps
Structured Products with Exotics in FX/IR markets
FX-linked swaps: Hanseatic swap, corridor swap, turbo swap
Wedding cake investment, onions
Forward Extra and its variations
Case study on IR swap linked to EUR-CHF self-quanto options
Power-Reverse Dual Currency (PRDC) bonds and their impact on the USD-JPY skew
Accumulators and Target Forwards
Knock-out forward, fader, accumulator
Case Study TARF, Profit Target Forward (used for corporates)
Case Study Pivot Target Forward (used for private banking)
Multi-Currency Contracts
Product overview with applications: quanto options, baskets, spreads, best-ofs, outside barriers
Correlation: implied correlations, correlation risk and hedging, currency triangles and tetrahedra
Hands-on approach to include the impact of smiles on the basket price via optimal strike decomposition
Workshop: Pricing and correlation hedging a two-currency best-of: calculate your own sensitivities and hedge vega and correlation risk