In particular, derivatives in the currency and mortgage markets have been subject to liquidity risk that was not reflected in the pricing of the option when sold. Since higher interest rates and lower dividends increase the forward prices, a buyer of Worst-Of call is long interest rates and short dividends. And an option on the U. Click here to view the article in PDF format Sponsor content. Such assets are exposed to two uncertainties— price and quantity.
The payoff for a Worst-Of put option is always higher than a payoff for a basket put option on the same underlyings and consequently a Worst-Of put option is costlier than a basket put option on the same underlyings. Interest rates and dividends - Higher the forward prices of the individual underlying stocks, lower will be the price of the put.
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Traders can bet directly on the divergence between implied and realised correlation by using a correlation swap. As with any market variable, supply and demand effects can strain or distort the pricing of implied correlation. Contracts that couple directional forex bets with plays on implied correlation itself have proven popular in recent months. These contracts include dual digitals, worst-of options and basket options. In contrast to the correlation swap, these contracts do not have explicit sensitivity to realised correlation, but nevertheless implied correlation plays a crucial role in their characteristics and pricing.
Dual digital — this is the multi-currency-pair generalisation of a European digital option; the buyer receives a fixed rebate if two currency pairs are above or below pre-defined target levels at expiry.
Worst-of option — this is the multi-currency-pair generalisation of a plain vanilla European option; the buyer receives the payout of the worst-performing of several normally two or three vanilla options. Vanilla options have more in-built leverage than European digitals because spot has to move significantly beyond the strike to generate significant value. It should therefore come as no surprise that the discounts can be even more eye-catching for worst-of options compared with dual digitals.
Returning to strategies benefiting from generalised EUR weakness, it should be evident that a worst-of EUR put versus a basket of other currencies expresses the leveraged view very neatly. The attainable discounts have led some traders to employ pure worst-of carry strategies. It is clear then why such options proved attractive against a backdrop of falling volatilities — constructed in this way, the embedded cross-currency correlations result in a significantly reduced net vega exposure when compared to vanilla options.
Recognising the growing importance of this suite of products, RBS has built advanced tools to seek out the most favourable currency and strike combinations, thereby providing its clients optimised risk profiles.
Advanced risk-management tools have also been implemented to assist RBS with managing the resultant exposures, which in turn enables the bank to perform its role as one of the leading partners in this space.
Correlation is an area that the bank views as crucial to the future of the currency options business, and is therefore an area to which it continues to devote significant resources. Click here to view the article in PDF format. You need to sign in to use this feature. As with other options, a basket option gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price, on or before a certain date.
This exotic option has all the characteristics of a standard option, but with the basis of the strike price on the weighted value of its components. Currency baskets are the most popular type of basket option, and they will settle in the holder's home currency. Because it involves just one transaction, a basket option often costs less than multiple single options. For example, a global corporation such as McDonald's might buy a basket option involving Indian rupees and British pounds, in exchange for U.
Technically, an equity index option is a basket option because the underlying asset is a weighted basket of component stocks. However, because the index is a standardized basket where a third party calculates and maintains it, index options trade similar to individual options and are not considered exotic options.
The most important feature of a basket option is its ability to efficiently hedge risk on multiple assets at the same time.
Rather than hedging each individual asset, the investor can manage risk for the basket, or portfolio, in one transaction. The benefits of a single transaction can be great, especially when avoiding the costs associated with hedging each and every component of the basket or portfolio.
Since each basket is unique, these options involve two counterparties and trade over-the-counter. This type of trading limits liquidity , and there is not a guaranteed way to close the options trade ahead of expiration. Buy-Side Risk Management Technology Asset managers continue to face a rapidly changing operating environment. Currency Management Buy now. Browse by content type. FX Week staff 21 Jul Tweet.
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BREAKING DOWN 'Currency Option'
Jan 02, · FX Correlation Products - Best/Worst of Options, Dual Digitals, FX Quantos, Basket Options Something about correlation There's something about correlation which investors don't urhosting.ml: FXONOMICS. Worst-of option – this is the multi-currency-pair generalisation of a plain vanilla European option; the buyer receives the payout of the worst-performing of several (normally two or three) vanilla options. Vanilla options have more in-built leverage than European digitals because spot has to move significantly beyond the strike to generate. Hi, I'd like to learn more about these two types of fx exotic options both from a qualitative standpoint (i.e. motivations for trading, examples of trade.