It is time to start some derivative analysis. The aim of this chapter is to introduce the basic Greek exposures on European vanilla options. This is stylized Black-Scholes analysis with zero interest rates throughout; hence the forward rate is always equal to the spot rate and discounting considerations can be ignored. The charts within this chapter can be generated in Excel after completing Practical C.
A vanilla call option gives the right, but not the obligation, at maturity to buy spot (i.e., buy CCY1 versus sell CCY2) at the strike in the agreed notional. Exhibit 6.1 shows the value at maturity of a long (bought) vanilla call option over different spot levels. This value at maturity is often described as the option payoff.
For a short (sold) vanilla call option, the value at maturity is reflected in the spot-axis resulting in an increasingly negative value above the strike, as shown in Exhibit 6.2. As expected, a long position plus short position in the same contract results in zero value over all spots (i.e., no position).
The initial option premium is sometimes ...