An Fx options model that incorporates 25-delta strangles and 25-delta risk reversals. (1st January 2012)

• Record Type: Journal Article
• Authors: Vaidyanathan, K.
• Is Part Of: International journal of financial markets and derivatives. Volume 3:Number 1(2012)
• Page Start: 20
• Page End: 35
• Publication Date: 2012-01-01
• Subjects: foreign exchange derivatives -- exotic options' volatility models; Derivative securities -- Mathematical models -- Periodicals; Capital market -- Periodicals; 332.605
• Languages: English
• ISSNs: 1756-7130

Abstract

The paper suggests a new class of models (Q-Phi) to capture the information that the foreign exchange options market provides through the 25-delta strangles and 25-delta risk reversals. The model is able to capture the stochastic movements of a full strike structure of implied volatilities. We argue that extracting information through this model and pricing path-dependent and non-benchmark strike options is a better methodology than using a constant implied volatility. The model can be used to price exotic options and hedge them robustly with benchmark European options. It is easy to calibrate and the model parameters lend themselves to intuitive interpretation by a trader managing an Fx options book.