Advanced FX Options & Structured Products

"Very detailed, excellent view points from market participants, good technical coverage" Head of Finance, Capula Investment Management LLP Course Description The agenda of this course will offer delegates a thorough and practical understanding of currency option pricing and risks and will explain how options can be used in directional and non-directional strategies, together with their dynamic hedging implications. The programme will also focus on analysing, structuring and decomposing hedging, trading and investment strategies utilising both vanilla and exotic options. Delegates will construct and examine a wide variety of directional and non-directional strategies, formulate strategies to meet client exposure management and other objectives, and decompose a range of structured option strategies into their component parts. The impact of changing market conditions on the pricing and performance of these strategies will also be examined. Particular emphasis is placed on the dynamic interaction between option price determinants, the impact on portfolio risk of higher order risk properties of vanilla and exotic options (e.g. Vanna, Volga) and their pricing and risk management. Particular attention will be placed on higher order volatility risks Vanna and Volga, and their management within portfolios of vanilla and exotic option types. The programme will then focus on exotic options and a range of the more commonly executed structured FX products as well as their pricing and risk characteristics, in order to understand the motivations and rationale for their usage in a variety of different hedging and trading applications. Computer Excersises The training will comprise classroom-based teaching combined with computer based (Excel™ based) simulations and exercises. The course assumes a general understanding of ‘vanilla’ equity derivative instruments and does require basic mathematical fluency. Attend this intensive 3-day course and gain a comprehensive and detailed analysis of foreign exchange option derivatives. In particular, you will learn: The pricing, risk characteristics, and the dynamic behaviour of FX options in the context of the management of a portfolio of options How to analyse FX vanilla and exotic options To construct pricing an valuation models for currency option The use of FX options in a variety of directional and non-directional strategies Different hedging and trading applications for FX options Who Should Attend? This course has been specifically designed for the benefit of: Traders and dealers Derivatives sales personnel Structurers Risk managers and risk controllers Audit managers Corporate account officers Asset managers Corporate treasury personnel The course assumes a general understanding of ‘vanilla’ derivative instruments and, whilst not based upon a detailed theoretical or mathematical approach, does require basic mathematical fluency. Why not recommend this course to a colleague?
Day 1 FX Option Valuation – Principles and Option Pricing Models Fundamental properties of currency options Market conventions, terminology, price quotation basis (base Vs. quoted) Adapting the Black-Scholes framework to currency option modeling – Garman-Kohlhagen (1983) Rationalising distortions to the BSM framework - Non-continuous hedging - Volatility Skew and Kurtosis Problems with fitting the volatility smile dynamically Alternative model implementation methods: Numerical methods: Binomial lattice models Arbitrage-free derivation of a generalised binomial model Modelling spot and forward processes American and other path dependent options Volatility and time parameters in the binomial model; value determinants, price sensitivities Accounting and modeling for stochastic volatility - Vanna-Volga approach to constructing volatility surfaces - An explanation of sticky strike and sticky delta approaches - Quantifying the value of Volga, Vanna risks Local volatility modeling (Dupire et al.) - Problems with implementation - Hedging (Delta, Vega inaccuracies) Stochastic volatility (SV) modeling - Heston, Bates - SABR (Hagan et al.) - Hedging in a SABR model Case Study: Building option pricing models; valuation of European, American option styles Volatility Understanding volatility; the role of volatility in option pricing; volatility as an ‘asset class’ Historic, implied and realised volatility measures Volatility estimation: analysis of data samples; sample sizes; weighting sample data Volatility surfaces - Volatility smiles, skews - Volatility term structure effects - Volatility surfaces for FX options Volatility properties - Stochastic volatility - Mean reversion Volatility analysis - Volatility relative value analysis (Implied Vs. realized) - Smiles and Risk Reversals - interpretation and analysis - Fitting algorithms to the volatility surface Volatility trading strategies Option Risks; Hedging and Risk Management of Option Positions First order price risks: Delta, vega, theta, rho, phi Delta hedging and risk analysis - Dynamic risk management using delta - Delta hedging an option portfolio - Limitations and risks inherent in delta hedging PIN risk ‘Sticky strike’ effects Expiration effects Discontinuities; corrections Gamma; 2nd order option price sensitivity - Interpreting gamma - Gamma characteristics of in-, at- and out-of-the-money options - Long and short Gamma – risks and opportunity - Impact of Gamma on Delta hedge management - Implied Vs. realized volatility exposure - Gamma and ‘Shadow’ Gamma - Maximising profitability from Gamma management Theta; option price time decay - Theta as cost of carry - Inter-relationship between Theta, Gamma Vega; implied volatility risk sensitivity Rho; Interest rate sensitivity Understanding and actively managing interrelationships between option price sensitivities Active management of portfolio delta, gamma and vega risks Higher order risks - Delta time decay (charm) - Gamma sensitivity (speed, colour) - Vega (Vanna, Volga) - Rega and Sega risks - Risk reversals in management of skew (Vanna) risk - Butterflies in management of smile (Volga) risk Limitations of option ‘Greeks’ - Discontinuities in market price behaviour - Expiration trading - Strategies for managing risk when ‘Greeks’ experience large, discrete changes - Stress testing and portfolio scenario analysis; identifying potential future risks Case Study: Dynamic management of option risks in a single option position/portfolio context; Delta hedging and the analysis of trading p/l over a trading horizon. Exercise will involve managing position Gamma in order to attempt to maximise profitability Day 2 Basic Option Strategies Simple option strategies and their key characteristics Naked long and short call/puts Risk asymmetry: limited risk versus unlimited risk strategies Option spreads Call spreads and put spreads Tailoring limited risk strategies using option spreads Covered option strategies Covered calls and puts Rationale for using covered calls and puts – monetizing client views and ‘indifference’ Applications of Vanilla FX Options in Currency Risk Exposure Management Risk reduction (hedging) strategies with options Using options in corporate FX risk exposure management Simple hedging strategies - Vanilla call/put hedges - Tailoring client objectives and constraints using strike variation - Costs and benefits of options versus outright forward hedges Structuring tailored hedges with options - Zero cost collars/cylinders and range forwards - Option spreads and participating forwards - Seagulls - Extendible flat forwards Tailoring structures to meet client expectations, objectives and constraints: - Strike selection - ‘Pain thresholds’ – minimum/maximum strike levels - Budget constraints: zero cost strategies - Impact of market factors (swap points, volatility surfaces) on economics of strategies - Incorporating covered option sales into hedging strategies: finding client target or ‘indifference’ levels Rationale for using non-linear (options) vs. linear hedges - When is it rational to use options for hedging? - Comparative analysis of risk management strategies - Advantages/shortcomings of risk management solutions: cost/benefit analysis - Tailoring strategies to client risk management policy, constraints and expectations - Using options in hedging contingent risks Non-Directional (Volatility/time decay) Trading Strategies Calendar spreads - Rationale - Volatility term structure (calendar skew) impact - Sensitivities; volatility/time decay exposure Butterfly spreads - Structure and rationale - Risk characteristics - Skew effects - Structural variants: - Delta neutral - Vega neutral butterflies (Vega convexity trading) - Condor spread Straddles and strangles - Structure and rationale - Risk characteristics - Volatility trading; dynamic management - Skew risk Case Study: Structuring option strategies (spreads, collars, butterflies); examination of risk characteristics and position risk management through time Day 3 Exotic Options Exotic option classification Pay-off structure Motivations and applications of exotic options Pricing and valuation issues: Black-Scholes, analytical models; advantages and shortcomings Numerical methods (Binomial, Trinomial lattice models, Monte Carlo simulation) Modelling considerations for exotic option pay-offs Skew effects Exotic Options - Barrier Options Overview of types (knock-ins and knock-outs; reverse knock-in/out) - DOWN and OUT/IN - UP and OUT/IN Pricing and valuation of Barrier options - Analytic solutions - Parity relationships (European = knock-out plus a knock-in) - Numerical methods of Barrier option pricing - Pricing double barrier options and other variants - Impact of varying barrier parameters on performance, cost Hedging Barrier options - Risk sensitivities and their characteristics - Static replication of barrier option risks - Managing Greeks close to barriers; managing sign changes Risks of hedged positions Higher order sensitivities - Vanna, Volga sensitivities - Skew risk - The importance of higher order sensitivities in the management of barrier options Applications of Barrier Options - Trading and hedging applications - Trading optionality with barrier options – when to use and when not to use barrier options - Structured Barrier option strategies: - Forward plus/extra - Knock-in cylinders - KO Forwards - KO Collars - FX TARNs and Target Redemption Forwards Case Study: Barrier options workshop; construction of trading strategies   Digital and One Touch Options CASH or NOTHING Calls/Puts ‘One Touch’ digitals and rebates Contingent premium ‘pay later’ options Pricing of digital options Hedging and risk management of digital options - Delta hedging; risk management problems - Disappearing Greeks - Pricing using a volatility surface - Gamma, Vega, theta behaviour - Replication using spreads, risk reversals Quanto (Quantity Adjusted) Options Quanto derivatives Pricing quanto derivatives – Replication approach – Analytical approach – Pricing parameters – correlation and volatility inputs Hedging quanto derivatives – Correlation risk management Applications of Quanto options -- Hedging FX translation exposure – Foreign equity/domestic currency options – Structured notes with quantoed pay-offs Average Rate (Asian) Options Mechanics of average rate options Pricing and risk management characteristics Motivations and rationale for the use of Asian options – hedging with Asian options (Practical examples) Second Generation Exotic Options Exotic Barrier options - Digital barriers - 2KO and KIKO barriers - Parisian barriers - Outside barriers Corridors, faders and accumulators Multi-asset options - Spreads and baskets - Best-of and worst-of options Structured FX Products Structured FX hedge instruments - Barrier structures (forward plus) - Knock-in cylinders - Knock-out forwards - Fader and accumulator forwards Currency linked notes - Dual currency deposits - Reverse dual currency notes - Power Reverse Dual Currency Notes (PRDCs) Range accruals FX hybrids Case Study: Structuring, pricing and risk management of FX linked structured products Course Summary and Close