FX Barrier Options: A Comprehensive Guide for Industry by Zareer Dadachanji

By Zareer Dadachanji

This booklet is a quantitative quide to barrier strategies in FX environments.

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FX Barrier Options: A Comprehensive Guide for Industry Quants

This booklet is a quantitative quide to barrier concepts in FX environments.

Extra resources for FX Barrier Options: A Comprehensive Guide for Industry Quants

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There is an important qualitative difference between the two barrier option examples above. In the case of the up-and-out call, the barrier is placed at a level where the payoff would otherwise be non-zero, and hence a small change in spot which breaches the barrier will change the payoff from around USD 8,000 to zero. We say that there is a spike in the payoff. 25 Meet the Products 21 be zero, and the breaching of the barrier causes no payoff spike. The qualitative difference in the forms of risk to be managed in these two situations motivates the use of some specialist terminology to distinguish them: a knock-out barrier at zero payoff is called a normal knock-out, whilst a knock-out barrier at non-zero payoff is called a reverse knock-out.

An alternative notation is also sometimes to be seen in which a forward slash is written between the two currencies, like so: “EUR/USD”. Confusingly, although this notation suggests EUR per USD, it actually means exactly the same as EURUSD. For the most part in this book, we will be discussing the following three currency pairs: 1. EURUSD: US dollars per euro, spoken “euro-dollar”. 2. USDTRY: Turkish lira per US dollar, spoken “dollar-Turkey”. 3. AUDJPY: Japanese yen per Australian dollar, spoken “Aussie-yen”.

Payments do not have an expiry time, only a settlement date, so when we introduce a barrier feature, we must also add an expiry time, which defines exactly when the barrier ceases to be active. 24 FX Barrier Options If a one-touch or double one-touch contract is triggered, we know immediately how much payment needs to be made, so the following question arises: should the payment be made immediately or on the contract’s settlement date? In fact, two variants of every one-touch contract type exist, one which pays “immediately” (actually on the spot date of the date on which the barrier was triggered) and one which pays on the settlement date.

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