FX First Generation Exotics
A term used widely, but never and nowhere clearly defined. Today let me explain some approaches to classify and define this famous set of derivatives contracts.
For the sake of example we consider EUR/USD – the most liquidly traded currency pair in the foreign exchange market. Internationally active market participants are always subject to changing foreign exchange rates. To hedge this exposure an immense variety of derivatives transactions are traded worldwide. Besides vanilla (European style put and call) options, the so-called first generation exotics have become standard derivative instruments.
The term first generation exotic does not refer to a clearly defined set of derivatives contracts, especially not in a legal sense. However, it is universally agreed that Foreign Exchange Transactions (spot and forward contracts) and vanilla options are not in the set. It is also universally agreed that flip-flop-kiko-tarns and correlation swaps are not in the set either. We can then classify first generation exotics by:
- Time of Introduction: Here we consider the history and the time when certain contracts first traded.
- Existence of Standardized Deal Confirmations: We would classify a transaction as first generation exotic if there exists a standardized deal confirmation template, such as the ones provided by ISDA.
- Replicability: We would classify a transaction as first generation exotic if it can be statically or semi-statically replicated or approximated by spot, forward and vanilla option contracts.
- Trading Volume: We would classify a transaction as first generation exotic, if its trading volume is sufficiently high (and the transaction is not a spot, forward or vanilla option).
There can also be other approaches to classify first generation exotics. I would like to point out that a first generation exotic does not necessarily need to be a currency option. For example, a flexi forward can be considered a first generation exotic in terms of both timing and standardization, but is clearly not an option. A variance swap can be considered a first generation exotic in terms of both standardization and replicability, but is clearly not an option, because there is no right to exercise. Classification by trading volume would change the set of first generation exotics over time and is consequently not suitable for classification purposes. The various classifications would generate overlaps as well as differences. One could certainly argue to label barrier options as first generation exotic, because they would satisfy all of the above: timing, standardization, replicability and volume. For Asian options, the timing criterion would make them first generation as they started trading in Tokyo in 1987, but there is — even in 2017 — no standardized deal confirmation provided by ISDA. Power options satisfy timing and replicability, but not standardization or trading volume.
This leads to the effect that the transition between the generations is not strict and can depend on the person you ask and classification the respective person has in mind. A clean approach to classification could be sticking to the standardization, which would classify barrier options and touch products, as well as variance and volatility swaps as first generation exotic, based on the existing ISDA Definitions and their supplements. The question which transaction is standardized can then be viewed in light of ISDA’s Barrier Option Supplement, which appeared in 2005 and ISDA’s Volatility and Variance Swap Supplement, which appeared in 2013.
ISDA has extended the 1998 FX and Currency Options Definitions to the range of touch products and single and double barrier options, including time windows for barriers. These are
- options that knock in or out if the underlying hits a barrier (or one of two barriers) and
- all kind of touch products: a one-touch [no-touch] pays a fixed amount of either USD or EUR if the spot ever [never] trades at or beyond the touch-level and zero otherwise. Double one-touch and no-touch contracts work the same way but have two barriers.
The 2005 ISDA Barrier Option Supplement contains all the relevant definitions required to confirm these transactions by standardized short templates. It is clearly defined what a barrier event or a determination agent is. However, for purposes of classification, the product range covered by this ISDA supplement is not necessarily viewed as equivalent by all market participants. Moreover, the set of first generation exotics would then change each time ISDA publishes a new supplement.
My personal preference is to classify the set of first generation exotics by the time of introduction in the market. These would then include the Asian options that started trading in Tokyo in 1987, barrier options and touch contract introduced commercially in the 1990s, along with compound options. I still remember this list from a flyer that Citibank had produced in 1992 to expand their FX Options business with this new generation of products that had just gone live.
To turn final: did you ever try to use the 1998 ISDA FX and Currency Option Definitions to confirm a European Digital? A currency option as a legal contract constitutes the right to exercise for the holder of the option, and upon exercise a cash-flow is triggered: The holder pays the Call Currency Amount to the seller, and the sell pays the Put Currency Amount to the holder. The ratio of these two amounts is generally referred to as the strike price. Now, a quant, thinking that a European digital is just another contract with a different path-independent payoff, much like a vanilla option’s payoff, will face difficulties squeezing this contract into the Currency Option framework. The Put Currency Amount is zero, and hence, the holder would naturally always exercise. For this reason, it is not uncommon to confirm a European digital as an obligation to pay for the seller rather than a holder’s right to exercise and receive. I am sure you expected that anyway.
I would like to thank our readers, team, business partners and clients for the valuable impulses this year, wish you all a wonderful holiday season and good spirit for 2018.
Uwe Wystup, Managing Director of MathFinance
ISDA 1998 FX and Currency Option Definitions
ISDA 2005 Barrier Option Supplement
ISDA 2013 Volatility Swap and Variance Swap Supplement
POSTER SESSION AT THE MATHFINANCE CONFERENCE
Registration from December 1, 2017 until January 15, 2018
We are pleased to once again host a poster session at the Conference. This is an excellent opportunity, particularly for doctoral and post-doctoral students to present their research results to a broader community of academics and professionals.
- Submission of posters latest by February 23, 2018
- Winner Award on March 12, 2018
Our independant jury consisting of
Prof. Dr. Natalie Packham, Professor of Mathematics and Statistics, (Berlin School of Economics and Law)
Dr. Michael Einemann, Risk Methodology Specialst, (Deutsche Bank)
Prof. Dr. Andrija Mihoci, Professor of Statistics and Econometrics, (Technical University Cottbus)
will nominate the best five posters to be presented at the conference. Participation in the Conference is mandatory for exhibiting the posters.
The winner of the best poster will receive free admittance to the whole conference.
Poster size should be A1 (841 x 594 mm /33.1 x 23.4 in). Please submit your ideas as a pdf document to firstname.lastname@example.org.
Date: April 16 – 17, 2018
Venue: Frankfurt School of Finance & Management, Adickesallee 32-34, 60322 Frankfurt am Main
MathFinance Conference has been successfully running since 2000 and has become one of the top quant events of the year. The conference is specifically designed for practitioners in the areas of trading, quantitative and derivatives research, risk and asset management, insurance, as well as academics.
As always, we expect around 100 delegates both from the academia and the industry. This ensures a unique networking opportunity which should not be missed. A blend of world renowned speakers ensure that a variety of topics and issues of immediate importance are covered.
Our confirmed speakers for 2018 include:
- Dr. Tomasz Bielecki (Illinois Institute of Technology)
- Dr. Jürgen Hakala (Leonteq)
- Prof. Jessica James (Commerzbank): Cross Currency Basis – what drives it?
- Dr. Christian Kappen (d-fine): Approximating MVA along Low-Dimensional State Spaces
- Bryan Liang (Bloomberg): volatility modelling/derivatives pricing
- Dr. Jacopo Mancin (Barclays): Volatility Swaps: PDE pricing improvements for LSV frameworks
- Dr. William McGhee (NatWest Markets): Machine Learning in Quantitative Finance
- Bereshad Nonas (Scope Ratings AG): Estimation of Hedge Fund Performance
- Prof. Rolf Poulsen (University of Copenhagen): How Accurately Did Markets Predict the GBP/USD Exchange Rate Around the Brexit Referendum?
- Adil Reghaï (Natixis): The fair pricing under local stochastic volatility
- Artur Sepp (Julius Bär): Applications of machine learning for volatility trading and asset allocation
- Prof. Dr. Uwe Wystup (MathFinance): FX Volatility 101 Exam
There will also be a Mini-Symposium on “Computational Finance” organized by Prof. Karel in’t Hout.
Click here for more Information on the upcoming conference.
Please click here for registration (single / group):
Single tickets are priced at our prime price of EUR 735 (+VAT) which ends on January 31, 2018.
Academics pay 525 EUR (+VAT) at all times. We kindly ask for proof of your affiliation.
Group prices (3 or more from the same institution) are at EUR 735 (+VAT) pp.
Discounted price of EUR 840 (+VAT) is valid from February 1 until February 28, 2018.
Regular price from March 1, 2018 is EUR 1.050 (+VAT).
EINLADUNG ZUM DATA SCIENCE-WORKSHOP!
Termin: 21. und 22. März 2018
Erleben Sie die Industrie im Umbruch, in der die Verzahnung von innovativen mathematisch-naturwissenschaftlichen Methoden mit ökonomischer Expertise immer wichtiger wird. Konzipieren, entwickeln und implementieren Sie Algorithmen basierend auf klassischen numerischen Verfahren, etablierten Simulationstechniken oder Machine Learning Prinzipien und kombinieren Sie diese mit modernen Technologien. Machen Sie Innovationen nutzbar und gestalten Sie die Zukunft unserer Kunden mit.
Wenn Sie gerade dabei sind, Ihre akademische Karriere mit einem exzellenten Abschluss (MSc, Diplom oder Promotion) zu krönen und bereit sind, die Grenze zwischen akademischer Theorie und Unternehmenspraxis zu überschreiten, dann sind wir
gespannt auf Sie.
d-fine ist mit über 700 Beratern und Büros in Berlin, Frankfurt, London, München, Wien und Zürich eines der größten spezialisierten Beratungsunternehmen in Europa. Wir fokussieren höchste naturwissenschaftlich-technische Kompetenz auf die anspruchsvollen Herausforderungen unserer Kunden.
Unsere Kunden schätzen unseren kompromisslos hohen Qualitätsanspruch und vor allem, dass wir diesen Anspruch auch
realisieren. Das beginnt schon bei der Auswahl unserer Mitarbeiter (m / w).
d-fine. Die Spezialisten für Risk&Finance.
2tägiger Workshop mit Vorträgen zu aktuellen Beratungsthemen wie Data Science, Predictive Analytics und Artificial Intelligence mit Fallbeispielen und Erfahrungsberichten. Bewerbungsschluss ist der 29. Januar 2018.
Termin: 21. und 22. März 2018
Ort: Schlosshotel Kronberg im Taunus
An der Hauptwache 7
60313 Frankfurt am Main
T +49 69 907 37- 555
Senior Quant/ Consultant
We are looking for senior quant / consultant in the areas of
- Actuary with 5 to 7 years of experience in insurance or re-insurance
- Experience in quantitative Risk Management in relation to regulatory issues (Solvency II)
- Experience in Capital Management
- Quant with 5 to 7 years of experience in Banking, ideally in Trading
- Experience in quantitative Risk Management in relation to regulatory issues (Basel III)
- Experience in Capital Management
- Quant with 5 to 7 years of experience in Asset Management (Funds, Insurance and Family Offices), ideally with emphasis on Risk Management
- Experience in quantitative Risk Management in relation to regulatory issues (German KAGB and KARBV)
Please send us your CV to email@example.com
Do the following apply to you?
- Master degree or diploma in (business) mathematics or physics
- PhD or CFA is a bonus
- First experiences in mathematical finance is desirable
- Very good programming skills, e.g. C++, Python or Matlab
- Good language skills in German and English
- Outstanding analytical skills and a problem-solving attitude
- High motivation to develop your knowledge and skills
- Good communication skills and team spirit
Then we would like to hear from you. Please send us your CV to firstname.lastname@example.org