Chapter 9Vanilla FX Derivatives Risk Management

FX derivatives trading portfolios contain different types of deal: vanilla options, exotic options, spots, forwards, and so on. To risk manage derivatives positions traders use Greeks; the exposures of the position to market changes. Greeks are calculated on each deal in the portfolio and then aggregated together. For a given market move, some deals in the portfolio will make money or, for example, get longer vega, and others will lose money or get shorter vega: Traders only care about the net impact from all deals. For this reason traders primarily describe their positions in terms of long or short positions in aggregated Greek exposures. For example, an FX derivatives trader may describe their position in a given currency pair as “flat delta, short topside gamma, and long vega.”

As markets move, positive or negative P&L is generated from different aggregated exposures within the position. The most important exposures are to spot (delta exposure) and ATM volatility (vega exposure). There are also exposures to CCY1 and CCY2 interest rates (rho exposures), exposures to curve moves in these instruments, plus exposures to the shape of the volatility surface. Finally, exposures are not static: Recall the gamma and vega profiles for vanilla options from Chapter 6; exposures change as the market moves or time passes.

For these reasons, trading an FX derivatives position is not straightforward. To simplify analysis, traders often consider ...

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