Thursday, July 1, 2010

From Spot FX to FX Options (maybe)

Sorry for having been a bit absent these last few weeks, I am considering moving towards FX options trading, and I have therefore been studying this very different area.

This idea came to me quite accidentally. A few weeks ago, I bought "The blank swan" by Elie Ayache, out of curiosity really; I started reading it and after about 30 pages, even though, I got the gist of his ideas (which are more philosophical than technical), I nonetheless realized that I may enjoy the book more if I was a bit more knowledgeable in Options Trading. Until then, I had browsed through some mathematical finance books, but never went into much of the details.
I therefore did that and acquired Espen Gaarder Haug'"Derivatives: Models on Models", I am still reading it, but I already have realised how powerful Options trading can be.

As I see it, traders are to face two unknowns: the volatility and the direction of the move. So far, I don't think analytical tools provide for a very good prediction in terms of the direction, but I tend to think that volatility can be foreseen in a better way, albeit far from perfect.
Nonetheless, it is very possible to make money in Spot FX, the uncertainty about direction can indeed be compensated by a proper money management strategy (that can be found in many trading books, see those by Van Tharp for instance), but Options trading seems to be able to do that more efficiently by hedging the risk by means of a combination of options, diminishing thereby the exposure to direction while maintaining a profit potential out of the volatility variations. And this is only one aspect of Options Trading, as it appears to offer a rich range of other approaches to trading.
And last but not least, it also proposes rather stimulating intellectual challenges.

My knowledge of these combinations is still too incomplete for me to detail much more at this level, I shall therefore continue to explore this area in the next few weeks, and will confirm whether I chose to trade FX Options in the future. If so, one must expect some changes in the content of this blog, even though I will continue to look at technical tools to analyse the "underlying" time-series, I may concentrate as well on some portfolio strategy issues.

8 comments:

Alberto Santini said...

There are many resources about Options Math. My preferred is the following one:

http://stotastic.com/wordpress/2010/05/black-scholes-without-the-junk/

And

http://stotastic.com/wordpress/2010/05/smiling-volatility/

Esper's site is interesting because collects Black-Scholes implementation in different languages:

http://www.espenhaug.com/black_scholes.html

Jean-Philippe said...

Hi Alberto,

Thanks for the sites, they look interesting.
So far the best book I have come through for financial mathematics is the one by Shiryaev:
http://www.amazon.com/gp/product/9810236050/ref=s9_simh_gw_p14_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-2&pf_rd_r=0WZCF54TGHRXEXDEX8VJ&pf_rd_t=101&pf_rd_p=470938631&pf_rd_i=507846

I don't own it yet, but I read several passages at the library, and it really is very good, both in terms of rigor and clarity. It is also very insightful, presenting some original proofs that provide the reader with a deeper understanding of the matter.

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