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FX Derivatives Trader School by Giles Jewitt

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Chapter 2Introduction to FX Derivatives

The FX market can be split into three main product areas with increasing complexity:

  1. Spot: guaranteed currency exchange occurring on the spot date.
  2. Swaps / Forwards: guaranteed currency exchange(s) occurring on a specified date(s) in the future.
  3. Derivatives: contracts whose value is derived in some way from a reference FX rate (most often spot). This can be done in many different ways, but the most common FX derivative contracts are vanilla call options and vanilla put options, which are a conditional currency exchange occurring on a specified date in the future.

Vanilla Call and Put Options

Vanilla FX call option contracts give the right-to-buy spot on a specific date in the future while vanilla FX put option contracts give the right-to-sell spot on a specific date in the future. The term vanilla is used because calls and puts are the standard contract in FX derivatives. The vast majority c02-math-0001 of derivative transactions executed by an FX derivatives trading desk are vanilla contracts as opposed to exotic contracts. Exotic FX derivatives (covered in Part IV) have additional features (e.g., more complex payoffs, barriers, averages).

To understand how call and put options work, forget FX for the moment and think about buying and selling apples (not Apple Inc. stock, but literally the green round things you eat). Apples currently cost 10p each. ...

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