Title: An Fx options model that incorporates 25-delta strangles and 25-delta risk reversals

Authors: K. Vaidyanathan

Addresses: Quantum Phinance, No. 404, H-2, Riddhi Gardens, Film City Road, Mumbai – 400097, India

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.

Keywords: foreign exchange derivatives; exotic options; volatility models; risk reversals; hedging.

DOI: 10.1504/IJFMD.2012.053324

International Journal of Financial Markets and Derivatives, 2012 Vol.3 No.1, pp.20 - 35

Received: 21 Feb 2012
Accepted: 06 Nov 2012
Published online: 30 Aug 2014 *

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