FX Option Performance. Peter Billington

>

      Jessica James

      FX Option Performance

For other titles in the Wiley Finance series please see www.wiley.com/finance

      FX Option Performance

       An Analysis of the Value Delivered by FX Options Since the Start of the Market

      JESSICA JAMES

      JONATHAN FULLWOOD

      PETER BILLINGTON

      This edition first published 2015

      © 2015 Jessica James, Jonathan Fullwood and Peter Billington

      Registered office

      John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom

      For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please visit our website at www.wiley.com.

      The right of the authors to be identified as the authors of this work has been asserted in accordance with the Copyright, Designs and Patents Act 1988.

      All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher.

      Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.

      Designations used by companies to distinguish their products are often claimed as trademarks. All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners. The publisher is not associated with any product or vendor mentioned in this book.

      Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. It is sold on the understanding that the publisher is not engaged in rendering professional services and neither the publisher nor the author shall be liable for damages arising herefrom. If professional advice or other expert assistance is required, the services of a competent professional should be sought.

      Library of Congress Cataloging-in-Publication Data

      James, Jessica, 1968–

      FX option performance: an analysis of the value delivered by FX options since the start of the market / Jessica James, Jonathan Fullwood, Peter Billington.

      pages cm. – (The wiley finance series)

      Includes index.

      ISBN 978-1-118-79328-2 (hardback) 1. Options (Finance) I. Fullwood, Jonathan, 1976– II. Billington, Peter, 1948– III. Title.

      HG6024.A3J355 2015

      332.64′53–dc23

2015001988

      A catalogue record for this book is available from the British Library.

      ISBN 978-1-118-79328-2 (hbk) ISBN 978-1-118-79326-8 (ebk)

      ISBN 978-1-118-79327-5 (ebk) ISBN 978-1-118-79325-1 (ebk)

      Cover Design: Wiley

      Top Image: ©iStock.com/Maxiphoto

      Bottom Image: Gears ©iStock.com/Marilyn Nieves

      Business Graph: ©iStock.com/kickimages

      Certain figures and tables compiled from raw data sourced from Bloomberg

JJ: To my sister AliceJF: To LucyPB: To Gemma, Jamie, Felix and Orson

      About the Authors

      Prof Jessica James

      Jessica James is a Managing Director and Head of FX Quantitative Solutions at Commerzbank AG in London. She has previously held positions in foreign exchange at Citigroup and Bank One. Before her career in finance, James lectured in physics at Trinity College, Oxford. Her significant publications include the Handbook of Foreign Exchange, Interest Rate Modelling and Currency Management.

      Jessica is a Managing Editor for the Journal of Quantitative Finance, and is a Visiting Professor both at UCL and at Cass Business School. She is a Fellow of the Institute of Physics and has been a member of their governing body and of their Industry and Business Board.

      Dr Jonathan Fullwood

      Jonathan Fullwood began his career in finance in 2002 and has since held positions in research, sales and trading at Commerzbank AG in London. He was awarded a CFA charter in 2007 and remains a member of the CFA Institute.

      Before his career in finance he graduated with first class honours in physics from the University of Manchester, where he also worked as a mathematics tutor. Jonathan completed his particle physics doctoral thesis in 2001, on work carried out at the Stanford Linear Accelerator Centre.

      Peter Billington

      Peter Billington is Global Head of FX Exotic Options at UniCredit in London. Since 1993 he has worked in FX option trading roles for Standard Chartered Bank and BNP Paribas and has traded metals for Dresdner Kleinwort Wasserstein. He has also worked at Commerzbank AG in several positions, including that of Global Head of FX Trading.

      Prior to his career in finance, Peter read mathematics and then mathematical modelling and numerical analysis at the University of Oxford.

      CHAPTER 1

      Introduction

      1.1 WHY READ THIS BOOK?

      Let's be honest, there is no shortage of books on Foreign Exchange (FX) options. There are plenty of places, online and on paper, where you can read about how to value FX options and associated derivatives. You can learn about the history of the market and how different valuation models work. Regular surveys will inform you about the size and liquidity of this vast market, and who trades it.

      This is not what this book is about. This is about what happens to an option once it is bought or sold. It is about whether the owner of an option had cause to be happy with their purchase. It is about whether FX options deliver value to their buyers.

      In the financial markets, there is huge and detailed effort made to value contracts accurately at the start of their lives. Some decades ago this work was begun in earnest when Black and Scholes published their famous paper [1]. Perhaps indeed we could say it started in 1900 when Bachelier derived a very similar model [2] though this was not followed up on. But, in general, quantitative researchers in the markets and in universities spend long hours to devise ways of correctly valuing complex contingent deals under sets of assumptions which make the mathematics possible.

      But are these assumptions right, i.e. over time, do they turn out to have been correct? Bizarrely, they do not have to have been ‘correct’ to continue to be used; later in the book we will give some detailed examples of assumptions that turn out to be manifestly incorrect. For an option, we can say that in an efficient (‘correctly priced’) market, on average, we would expect an option to pay back the money it cost in the first place – less costs, of course.1 In this book we will use terms like ‘mispriced’ or ‘misvalued’