Chapter 2
Trading Currency Options
I now proceed to the main topic of this book, the specialized field of options on foreign exchange. I focus on vanilla European puts and calls on foreign exchange, as well as on some of the more popular exotic varieties of currency options that are covered in the final chapters.
THE INTERBANK CURRENCY OPTION MARKET
Commercial and investment banks run the currency option market. The same money-center dealers that constitute the core of the spot and forward foreign exchange market are the most powerful market makers of currency options. For this reason, this book generally uses the conventions and terminology of the interbank foreign exchange option market.
Currency options are used by currency hedgers, traders, speculators, portfolio managers, and, on occasion, by central banks.
Modern trading in currency options began in the 1970s and 1980s in the venue of the listed futures and options markets of Chicago, Philadelphia, and London. Trading was concentrated in options and futures options on only a handful of major exchange rates. A structural change occurred in the 1990s, when the bulk of trading in currency options migrated “upstairs” to bank dealing rooms.
Once installed in the domain of the interbank foreign exchange market, option trading exploded in volume. What is more, currency options began to key off of the full gamut of exchange rates. In the mid-1990s, trading in exotic currency options began to develop at a rapid pace. Today, dealers ...
