delta neutral strike FXO, briefly

d1 = 0

Therefore, |put delta| = call delta = N(d1) = 0.5

According to Fang Chao:
call delta = N(d1)
put delta = 1 – N(d1)

Q: is it always true that |put delta| + call delta = 1?
A: I think so, if without dividend. See

earning/paying the "roll" in FX swap

Tony gave an example of sell/buy NZDUSD.    NZD is high yielder and kind of inflationary. Therefore, far rate is Lower. We sell high buy low, thereby Earning the swap points.

Buy/Sell USDJPY is another example. USD is high yield, and inflationary, so far rate is Lower. We buy high, sell low, therefore paying the swap points.

paradox – FX homework#thanks to Brett Zhang

label – math intuitive


Q7) An investor is long a USD put / JPY call struck at 110.00 with a notional of USD 100 million. The current spot rate is 95.00. The investor decides to sell the option to a dealer, a US-based bank, on day before maturity. What is the FX delta hedge the dealer must put on against this option?

a) Buy USD 100 million

b) Buy USD 116 million

c) Buy USD 105 million

d) Buy USD 110 million


Analysis: The dealer has the USD-put JPY-call. Suppose the dealer has USD 100M. Let’s see if a 1 pip change will give the (desired) $0 effect.


at 95.00

at 95.01, after the 1 pip change


value (in yen) of the option is same as value of a cash position

(110-95)x 100M = ¥1,500M

(110-95.01) x 100M = ¥1,499M

loss of ¥1M

value (in yen) of the USD cash

95 x 100M = ¥9,500M

95.01 x 100M = ¥9,501M

gain of ¥1M

value of Portfolio




Therefore Answer a) seems to work well.


Next, look at it another way. The dealer has the USD-put JPY-call struck at JPYUSD=0.0090909. Suppose the dealer is short 11,000M yen (same as long USD 115.789M). Let’s see if a 1 pip change will give the (desired) $0 effect.


at 95.00 i.e. JPYUSD=0.010526

at 95.01 i.e. JPYUSD=0.0105252, after the 1 pip change


value (in USD) of the option is

same as value of a cash position

(0.010526-0.009090)*11000M =

$15.78947M (or ¥1500M, same as table above)


$15.77729M (or ¥1498.842M)

loss of $0.012187M


value (in USD) of the short

11,000M JPY position

-0.010526 * 11000M= -$115.789M

-0.0105252*11000M = -$115.777M


gain of

$0.012187M (or ¥1.1578M)

value of Portfolio




Therefore Answer b) seems to work well.


My explanation of the paradox – the deep ITM option on the last day acts like a cash position, but the position size differs depending on your perspective. To make things obvious, suppose the strike is set at 700 (rather than 110).

1) The USD-based dealer sees a (gigantic) ¥70,000M cash position;

2) the JPY-based dealer sees a $100M cash position, but each “super” dollar here is worth not 95 yen, but 700 yen!


Therefore, for deep ITM positions like this, only ONE of the perspectives makes sense – I would pick the bigger notional, since the lower notional needs to “upsized” due to the depth of ITM.


From: Brett Zhang

Sent: Monday, April 27, 2015 10:54 AM
To: Bin TAN (Victor)
Subject: Re: delta hedging – Hw4 Q7


You need to understand which currency you need to hold to hedge..


First note that the option is so deeply in the money it is essentially a forward contract, meaning its delta is very close to -1 (with a minus sign since the option is a put). It may have been tempting to answer a), but USD 100 million would be a proper hedge from a JPY-based viewpoint, not the USD-based viewpoint. (Remember that option and forward payoffs are not linear when seen from the foreign currency viewpoint.)


To understand the USD-based viewpoint we could express the option in terms of JPYUSD rates. The option is a JPY call USD put with JPY notional of JPY 11,000 million. As observed before it is deeply in the money, so delta is close to 1 (positive now since the option is a call). The appropriate delta hedge would be selling JPY 11,000 million. Using the spot rate, this would be buying USD 11,000/95 million = USD 116 million. 


On Sat, Apr 25, 2015 at 2:21 AM, Bin TAN (Victor) wrote:

Hi Brett,

Delta hedging means holding a smaller quantity of the underlier, smaller than the notional amount, never higher than the notional.

This question has 4 answers all bigger than notional?!



x-ccy basis swap – FX homework3 revelations

For x-ccy fixed/fixed IRS, There are 2 levels of learning
11) the basic cash flows; how this differs from IRS and FX swap …This proves to be more confusing than expected, and harder to get right. Need full-blown examples like course handout from Trac consultant. It’s frustrating to re-learn this over and over. May need to work out an example or self-quiz.
22) the underlying link to x-ccy basis swap
A1b: Either issue EUR fixed bond or USD fixed then somehow swap to EUR
A1: fixed USD
A4: euro. Yes. They can simply convert the USD fund raised, in a detachable spot transaction. This is fully detachable so not part of the currency swap at all.
A9: 0 point. Rate is the trade date spot
A2 no

11) Self-quiz on the Trac illustration, to go thin->thick->thin and develop intuition.
Q1: before the deal, is Microsoft already an issuer of fixed or floating bond? What currency?
Q1b: Before issuing any debt whatsoever, what are Microsoft’s funding choices?
Q2: Is there any principal exchanged on near date (i.e. shortly after trade date)?
Q3: Microsoft is immune to FX movement or USD rate movement or EUR rate movement? What is Microsoft betting on?
Q4: Microsoft needs funding in what currency? Are they getting that from the deal?
Q9 (confusing): how is this diff from FX swap? How is swap point calculated?

My mistake in this homework was forgetting that the far-date FX rate used to exchange the principal amount is the rate pre-determined on trade date, written into the contract, and not subject to FX movement up thereafter.

22) I now think the x-ccy basis swap spread is important to any x-ccy IRS aka “currency swap”, because a x-ccy basis swap is an implicit part and parcel of it…. points that usd/aud [1] basis swap of 15 bp is interpreted as

“usd libor flat -vs- aud default floating rate + 15 bp, with tenor basis spread adjusted [2].”

[1] or aud/usd…. It doesn’t matter.
[2] in aud case, the default swap coupon tenor is same as USD and needs no adjustment

I guess the spread is positive because aud is a high yielder? Not sure

–The coca cola bond in
US issuers (needing usd eventually) of eur floating bonds [3] would use x-ccy basis swap to convert the euribor liability to a “usd libor + 33” liability, so the negative and growing spread (-33 now) hurts.

Warning — it’s incorrect to think “ok for this quarter my euribor liability is 2% for this quarter, so 2% – 33 bps = 1.67% and I swap it to a usd libor liability, so the bigger that negative spread, the lower my usd libor liability — great!” Wrong. The meaning of -33 is

“paying euribor floating rate (2% this quarter), I can find market makers to help me convert it into paying a usd libor+33”
“paying 2% – 33 bps on a euribor floating bond, I can convert it into paying a usd libor + 0 floating bond”

[3] fixed bond can be swapped to floating;wap2 explains
There is more demand for funding in one currency and more supply in another currency. For instance many Japanese banks have funding sources in JPY but have committments in USD. They therefore will swap their JPY (inflow) to USD (inflow) to cover their USD commitments. The basis swap spread reflects this supply and demand situation.

Assuming a tiny bid/ask spread, I believe a Japanese bank is equally willing to receive
– a stream of usd libor or
– a stream of jpy libor – 10 bps

By the no-arbitrage pricing principle, two floating rates should trade at par and the basis spread should be zero (Tony also covered this point in the 3rd lecture), but there’s more demand for usd libor inflow.

Similarly, after GFC, European banks need usd more than US banks need euro. see A typical bank would be indifferent to receiving
– a stream of usd libor or
– a stream of euribor – 34 bp explains that

the basis swap markets saw increased demand to receive USD funds in exchange for EUR. This excess demand drove the EURUSD basis swap spreads down to highly negative levels as counterparties were willing to receive lower interest payments in return for US dollar funds

FX, short term rate, YC…again

(labels – fixedIncome, original_content, z_bold)

I feel FX market mostly watch short term rates, not long term rates. Short-term typically means below 1 year.

– long term IR Futures are based on government debt + … other factors. Examples — T-futures, German Bund futures,…
– short term IR is usually based on OIS, Libor or similar inter-bank offer rates in other cities like Tokyo, Singapore, Hongkong …

Short term (including O/N) borrowing is probably more prevalent than long term borrowing. Credit risk grows significantly with the borrowing duration.

Yield Curve and Swap Curve are directly comparable. Yield curve is about spot Interest Rate. Swap curve is also about spot IR !! although swap curve is constructed using mostly forward Interest rates — only the first few (3) months of the curve data points are constructed using spot IR rates

* Conceptually, you can imagine we convert either spot IR or fwd IR to discount factors at various valuation dates.
** we could get a DF from 2040 to 2030.
** we could get a DF from 2042 to today.

From a discount curve, we can “back out” the spot rates for various tenors. A spot rate is directly related to a DF to today.

* Libor itself is a spot lending rate but Libor Futures and Libor swap contracts are about Forward lending rates — Very important

fx swap – mostly used for funding

Soundbyte — FX swap is a popular alternative to (secured) bank loan. is the best article to shed light on the “funding” usage of FX swap. (By the way, It also covers the ccy swap i.e. xccy IRS, which tends to be confused with fx swap.)

The term “funding” is unnatural to me. “Funding” basically means borrowing money for a fixed repayment period. Say I have a big project and need $555m. I typically borrow from a bank or issue a bond. Note with each “funding” requirement, there's a pre-defined repayment timeframe.

A similar verb is “raising” fund.

FX swap ^ FX loans – popularity=off balance sheet

One of the best-known motivation/attraction of FX swap over traditional FX loans is – off balance sheet.

The Trac consultancy trainers gave many specific examples. Context is commercial banking, because unlike listed securities, a “buy-side” has no way to trade FX swap on some exchange without a big bank facilitating. Most FX inventories are held by banks (even more than governments apparently). The biggest players are invariably the international banks + central banks, not big hedge funds.

Specifically, the context is a client (like IBM) coming to a commercial bank for a FX solution. Commercial banks are heavily regulated, more so than investment banks. One of the regulations is capital adequacy. Traditional loans to IBM would tie up too much capital in the bank – capital inefficiency. Even for the client (IBM), I feel borrowing would often require collateral.

FX swap in contrast requires much less capital.

A different form of IRS off-balance-sheet benefit is given in, applicable for a buy-side as well.

use swap point bid/ask to derive FX fwd outright bid/ask

(label – FX)

See other posts on fwd swap point interpretation.

See other posts on how to compute fwd outright bid/ask without swap points — using interest rate bid/ask.

Given spot bid/ask is 105.30/105.35 (whatever ccy pair – unimportant). Suppose swap points are quoted 1.10/1.05, we can deduce the asset currency is trading at a fwd Discount[1], because the swap quote is “high/low”. Fwd Discount means that fwd outright price is Lower than spot price. Always treat the first currency as a commodity like silver.

Fwd outright bid/ask of the “silver” are 105.30 – 1.10 / 105.35 – 1.05

Note this is not some expectation/prognosis of an upcoming event, to-be-known. Instead, the 105.30 – 1.10 = 104.20 price is for execution today. Only the settlement is 1Y later.

[1] Even if we don't know “Discount”, we can still figure out whether to subtract or add the swap points. Golden Rule [2] is, fwd outright bid/ask spread must be wider than spot bid/ask spread.

Therefore, Since swap bid (1.10) is Bigger than ask, we must Subtract it from spot bid. Subtracting a bigger number from bid is the only way to WIDEN the spread.

[2] in fact, the final bid/ask spread in fwd outright pips equals the spot spread + |swap point spread|. Here we take the abs value because we don't care if the swap points are quoted “high/low” or “low/high”.

FX Vol – Butterfly or Strangle@@

[[Managing Currency Risk Using Foreign Exchange Options]] says

Butterfly is a combination of ATM straddle and an OTM strangle, and is a more exact way of trading the smile of volatility.

The OTM strangle relates net premium, in volatility terms, over the ATM ( volatility) rate. The purchase (or sale) of an OTM Strangle still leaves the trader open to a change in the ATM rates, so it’s possible for a change in the smile shape to be compensated by a change in the ATM rates. To be more exact, trader can lock in the difference between the two (ATM vs OTM volatilities) by trading the butterfly spread.

UIP carry trade n risk premium

India INR interest could be 8.8% while USD earns 1.1% a year. Economically, from an asset pricing perspective, to earn the IR differential (carry trade), you have to assume FX risk, specifically the possible devaluation of INR and INR inflation during the hold period. 

In reality, I think INR doesn't devalue by 7.7% as predicted by UIC, but inflation is indeed higher in India.
In a lagged OLS regression, today's IR differential is a reasonable leading indicator or predictor of next year's exchange rate. Once we have the alpha and beta from that OLS, we can also write down the expected return (of the carry trade) in terms of today's IR differential. Such a formula provides a predicted excess return, which means the carry trade earns a so-called “risk premium”. 
Note, similar to the DP, this expected return is a dynamic risk premium (lead/lag) whereas CAPM (+FamaFrench?) assumes a constant time-invariant expected excess return.. 

FX vs IR trading desks, briefly

Now I know that in a large sell-side, FX trading is “owned” by 2 desks – the “cash” FX desk and the IR desk. Typically, anything beyond 3 months is owned by the Interest Rate desk (eg STIRT). It seems that these FX instruments have more in common with interest rate products and less in common with FX spot. They are sensitive to interest rates of the 2 currencies.

In one extreme case every fx forward (outright?) deal is executed as a FX spot trade + a FX swap contract. The FX swap is managed by the interest rate desk.

FX vol is a 3rd category, a totally different category.

sell-side on the FX Vol market

Backgrounder — The traditional meaning of a “sell-side” is basically a player who makes a living
– by commission or
– by earning bid-ask spread (market makers),
– but no insurance premium.
Such a player provides liquidity to the market and seldom consumers liquidity. In so doing they provide a valuable service to the market and are rewarded. In a sense, they sell liquidity.

I now think of fx options as even more like insurance than equity options. There's economic need for fx options. Demand comes from mostly (MNC) corporations. They buy this insurance because they need protection.

Since fx options are insurance, it's natural to classify the participants as sellers and buyers. I guess some big players in this market stay primarily on one side only. (Some banks may need to pay insurance premium just for hedging.) If that's true then the “sell-side” concept can be adjusted to mean players who make a living selling insurance who seldom buys the same insurance except for hedging.

The mainstream sellers are banks. If the interbank bid-ask vol spread is narrow, then these sellers will have little restraint from frequent buying/selling.

Compared to corporations, is there an even bigger category of buyers in the fxo market? I don't think so. I have no statistics, but I believe corporations are the most stable client base for the banks.

I think the commodity options (or options on futures) market isn't that active, but these option sellers are, likewise, insurers to provide for an economic need.

most popular/important instruments by Singapore banks

I spoke to a derivative market data vendor’s presales. Let’s just say it’s a lady named AA.

Without referring specifically to Singapore market, she said in all banks (i guess she means trading departments) FX is the bread and butter. She said FX desk is the heaviest desk. She said interest rate might be the 2nd most important instrument. Equities and commodities are not …(heavy/active?) among banks.

I feel commercial banks generally like currencies and high quality bonds in favor of equities, unrated bonds and commodities. Worldwide, Commercial banks’ lending business model is most dependent on interest rates. Singapore being an import/export trading hub, its banks have more forex exposure than US or Japanese banks. Their use of credit products is interesting.

AA later cited credit derivative as potentially the 2nd most useful Derivative market data for a typical Singapore bank. (FXVol being the #1). Actually, Most banks don’t trade a lot of credit derivatives, but they need the market data for analysis (like CVA) and risk management. She gave an example — say your bank enters a long-term OTC contract with BNP. You need to assess BNP’s default probability as part of counterparty risk. The credit derivative market data would be relevant. I think the most common is CDS

(Remember this vendor is a specialist in derivative market data.)

The FX desk of most banks make bulk of the money from FXO, not FX spot. She felt spot volume is higher but margin is as low as 0.1 pip, with competition from EBS and other electronic liquidity venues. What she didn’t say is that FXO market is less crowded.

She agreed that many products are moving to the exchanges, but OTC model is more flexible.

back-to-back ccy swap, basics

(see also P198 [[Marki]])


Both Investopedia and Wikipedia authors pick out this one motivation as the main usage of currency swap. — The reason companies use cross-currency swaps is to take advantage of comparative advantages. For example, if a U.S. company is looking to acquire some yen, and a Japanese company is looking to acquire U.S. dollars, these two companies could perform a swap. The Japanese company likely has better access to Japanese debt markets and could get more favorable terms on a yen loan than if the U.S. company went in directly to the Japanese debt market itself.

Wikipedia has a similiar comment — Another currency swap structure is to combine the exchange of loan principal with an interest rate swap. In such a swap, interest cash flows are not netted before they are paid to the counterparty (as they would be in a vanilla interest rate swap) because they are denominated in different currencies. As each party effectively borrows on the other’s behalf, this type of swap is also known as a back-to-back loan.

Wikipedia article later cites back-to-back as one of the 2 main uses of currency swaps.

y IR needed for spot ccy trading

Interest rate is fundamental to FX fwd pricing/trading. How can it possibly affect spot trading?

Well, if you are trading spot CAD/JPY as a cross on USD, but on a Friday evening (EST) the USD/JPY market is closed so you don’t receive USD/JPY quotes, you need latest spot IR (still available? Probably) to adjust your pricing.

I heard a comment that an FX spot trade is effectively a fwd contract to be settled not right away but in 2 business days.

speculator vs hedger in FX #my take

Here’s an easy way to differentiate speculator vs hedger in FX — Speculators have to “convert” back to domestic currency. They have no way to spend the foreign currency.

As soon as a speculator finds a way to spend $1k for that $1k she is no longer speculator. For example — Buying online; Buying a gift for a relative; Tourism; Invest in a foreign asset such as securities or properties.

Multinational corporations the archetypical hedgers. They also occasionally engage in speculative trading.

Hedge funds and retail traders are the archetypical speculators. I feel Banks are typically speculators. The Singapore subsidiary of Citibank is like a “trader” who has to convert everything back to SGD. The “trader” starts with a seed capital in SGD and tries to grow it. At the end of the year, any cash position in another currency should be kept small because it represents exposure. The Singapore bank has no justification to keep that exposure because the foreign cash can’t be used as cash. It’s like a silver position in your portfolio.

Think about the “convert back”. When do you convert to USD and never convert back? The real demand for USD is tied to the demand for US exports, including foreigners’ demand for American securities and properties. (However, global oil is not a US export but is quoted in USD??) Now we realize the demand for any currency is ultimately determined by the nation’s export. See also

RFQ ^ limit order ^ pseudo limit order

The dominant protocol of quote distribution is different between markets. Limit order and RFQ are well understood. As to of pseudo limit orders, there are 2 types —
– firm quotes invite market takers to click-and-trade, and are automatically executed (or rejected) by the dealer’s system
– Indicative quotes invite market takers to send RFQ.
* Which mode is dominant on an ECN? I guess firm quotes.

Note true limit orders are only available on a real exchange with a clearing house, which has real power/fund of execution. See

Note “dealer” means the same as “market maker” in this context. Usually a dealer keeps inventory. He can sell short but usually for a short durations.

Here are the dominant protocols —
* On exchanges — limit order. Be it equity, futures, listed options…
** for large block trades, I guess it’s RFQ, sent in private.
* equity ECNs — no limit order.
* institutional FX spot — 1) pseudo limit orders 2) RFQ for large orders (25+ mio). No enforcement/guarantee by ECN. Dealer always gets a last look
* institutional bond market — 1) pseudo limit order 2) RFQ
* institutional OTC equity option market — RFQ. Pseudo limit order are unheard-of
* Treasury — pseudo limit orders and RFQ
* IRS — 1) RFQ 2) pseudo limit orders. Most trades are large, so RFQ dominates.

#1 driver of long term FX #my take

Q: what is the #1 fundamental driver of long term FX rate between 2 currencies?

Is it PPP? I don’t think so.
Is it supply/demand? Short term yes; long term … this seems less relevant
%%A: “gold” backing.

In the beginning, every pound issued by the British monarch is as good as an ounce of gold (or whatever fixed amount of gold). Therefore anyone holding a pound note can exchange it for the equivalent amount of gold.  The monarch then decided to print more pound notes. Logically, all the existing and new pounds devalue. But the country also exports and, in a world of universal gold standard, earns gold. In a more realistic world, What is earned is foreign currency.

I believe Every Singapore dollar issued is backed by some amount of “gold” which in modern context means foreign reserve in a basket of hard currencies. By the way, there’s nothing harder than gold. As the national economy expands, more goods are produced domestically so the CB could issue more SGD, but I guess the CB waits until the goods are exported[2] and foreign currency earned. Such a prudent practice helps ensure every SGD is fully backed by sufficient “gold”.

[2] incoming tourists also spend their own currency like JPY, therefore contributing to the Singapore foreign reserve. If tourists sell their JPY for SGD outside Singapore, the JPY amounts tend to flow into the global banking systems and back to Singapore banks. I think non-Singapore banks don’t want to go long or short SGD for large amounts, so they would eventually exchange with Singapore banks including Citibank, HSBC, SCB, BOC.

In general, a hard currency is more deeply *backed* by gold than a weak currency. Alternatively, the issuing central bank has other capabilities (besides gold reserve) to maintain the *strength* of her currency. This strength depends on Current Account and economic growth — the 2 fundamentals. Another factor is global competitiveness, but this is often measured by the capacity to export and compete on global markets. After all, it still seems to boil down to earning enough foreign currency to back our own currency — “gold” backing in disguise.

Forex trading is Singapore’s strength

(A personal blog.)

I think for the past few months in the Singapore job market (java or c++), i didn't notice any fixed income, credit, equity domain roles. There are some cross-asset system positions, and there are commodities and FX positions. I feel FX is roughly half (up to 66%) of all the roles that pays a reasonable salary.

This is a hard lesson learned — I have to deepen my FX knowledge and track record otherwise the biggest chunk of jobs stay beyond my reach.

I feel in terms of domain knowledge, FX is more relevant (to high-end software jobs in Singapore) than volatility, bond math, exchange trading, structured products, etc

But why does FX pay above other fields. Here's what I came up with
– equity is small, less active in S'pore than HK. The high-paying eq-related jobs are usually in HK
– FX is perhaps more profitable at this moment
– FX is Singapore's traditional strength for decades. #4 behind Ldn, Nyk, Tky
– FX is high speed and high volume (in terms of market-data) so this places some stringent criteria on developer skill
– FX is more electronic, more standardized, more inter-connected than FI, commodities or derivative markets, on par with cash equities. More technical skills required.

It's interesting that FixedIncome has more complexity and has more profit potential but doesn't really pay comparable salary.

binary options, briefly

cash-or-nothing binary option and the asset-or-nothing binary option. CON is like a simple $5 bet on Worldcup Final.

I feel Binary options are important for
* interviews
* Often embedded in structured deals

Greeks (not that important) — Since a binary call is the first derivative (mathematical sense) of a vanilla call with respect to strike, the price of a binary call has the same shape as the delta of a vanilla call, and the delta of a binary call has the same shape as the gamma of a vanilla call

Usually European style

Exchange-traded, and also available OTC

Underlier can be FX, index, ETF or single stocks.

In FX, vanilla and Barrier options (knock…) are more popular than Binary options.

spot ^ fx-options — 2 "extreme" segments of FX market

Within the FX space, I get the impression that the trend of open standard, transparency, inter-connectedness, commoditization, shrinking spread and margin, widening competition among liquidity-pools (decentralization)… and all the other “good” stuff (to users) is primarily in the spot market, not much in the FX options market. The Reasons beneath are intriguing and offers a glimpse of the true drivers in FX markets.

Spot and Options are kind of 2 extremes in terms of commoditization…..

FX Futures (mostly on CME) is fully standardized and “bulldozed” as equities markets were bulldozed decades earlier. But I was told forward market is still bigger and more popular. Why?

Buy-side probably prefer standardized instruments — cheaper, transparent, fierce sell-side competition … but
Sell-side probably prefers the good old OTC contracts.

Dealers like things murky, and worry about too much transparency. The more murky, the more they can charge big spreads for the “service” they provide. A major reason for the shrinking margin in equity dealing desks over the past decades was the regulatory change to drive trading on to exchanges.

FX options are largely unaffected. Dealers don’t want to publish their quotes. Instead they respond to RFQ, according to a friend. (In theory, there might exist some *private* market maintained by a single market-maker, but I don’t know any.)

Fwd is similar. However, I was told the standard spot trade has a T+2 settlement and works like a short-term forward contract. Also, spot traders do a lot of rolling, so fwd trades and rates are ubiquitous.

Bank sends quotes (perhaps RFQ replies) to ECNs and also privately to individual clients. Known as “Bank feeds”. Notably, for a given currency pair at a given time, a bank sends slightly different spreads depending on audience — tiered quote pricer. A sign of market fragmentation, IMHO. Note, bank feeds aren’t always from commercial megabanks — investment banks also produce bank feeds.

credit-based forex pip spread says something like

In The interbank market (EBS and Reuters), banks trade based solely on the credit relationships they have established with one another. All can see the narrowest spread but each bank must have a specific credit relationship with another bank to trade at the best spread. The bigger the banks, the more credit relationships they can have and the better pricing they will get. Similarly, The larger a retail forex broker is in terms of capital, the better pricing it can get from the interbank market. If a client or even a bank is small, it gets wider spread.

I believe nothing else counts when it comes to the bid/ask spread you receive — only your credit counts. So how does a dealer size up your credit? I feel it’s largely due to your cash pile.

Why is an exchange conferred higher credit than all the banks and even the national government? Because an exchange has the most strict credit control and credit risk monitoring in place. No exchange has ever failed to deliver on its obligations.

parity rules in security valuations, briefly

Each is arbitrage-enforced, but to different extents.

parity – Put-call parity – doesn’t hold for American style. Most listed options are American style.
parity – In-out parity in barrier options

parity – Uncovered interest rate parity. Not widely observed.
parity – covered interest rate parity. Widely observed. See evidence in

parity – PPP i.e. purchasing power parity

import/export always involves forex trade#my take

A Chinese toy maker may advertise her products in both RMB and USD, and you may think that Walmart buying these products doesn’t involve any forex transaction.

However, what about the suppliers (and workers, and rent) of the Chinese manufacturer? Those payments must be in the local currency. (Most manufacturers have a margin below 30%, so) typically at least 70% of the money Walmart paid must be converted to RMB sooner or later.

Even the remaining 30% (or less) is often repatriated to local currency as well, but i can only speculate some of the reasons —
– dividend payout or owners taking out profit
– expand the business
– fund a new business

Incidentally, I believe the advertised USD price is often uncompetitive. Walmart (the buyer) gets more competitive prices from a forex dealer bank. Larger amount and higher credit of Walmat’s would help narrow the bid/ask spread. The advertised USD price is either rather high (for smaller customers) or requires a large order size.

barrier (knock) option – key words

Cheaper — insurance than vanilla options
FX — barrier options are more common than in eq
Equities — barrier options are much less common than vanilla options

touch-and-go — is considered a “knock” (or “breach” of barrier). Once out, out forever; Once in, in forever.

knock-price — strike-price can be identical or different from Barrier-price aka knock-price

knock-IN — up-and-IN, down-and-IN
knock-OUT — up-and-OUT, down-and-OUT

in-out parity  — only works for European options without rebate.

net positions in a sell-side FX trading account

In large dealer banks, each “dealing operation” has a single home currency as the reporting currency. At end of day, each book needs to report net positions in each foreign currency + its home currency. Each foreign currency can be either

– net long (or “overbought”)
– net short (or “oversold”)
– flat (or square)

That’s the end-of-today net position. Let’s look at end-of-tomorrow net position. If you have entered a forward buy USD/CHF, then you will have incoming cash flows in USD and cash outflow in CHF by end of tomorrow. You should estimate your end-of-tomorrow net position now.

retail^institutional FX ECNs

— retail —
Meta Trader
Ninja trader

— institutional, professional —
FXCM pro
flex fx

Difference? I believe institutional ECNs target buy-side –
– Hedge Funds,
– pension, mutual funds,
– insurance
– corporations with FX needs,
– banks not specializing in FX.

The big FX dealer banks (DB, Barcap, UBS, Citi …) are on the other side of the fence, as liquidity providers. In additional, Hedge Funds are often allowed to play liquidity providers.

quote/order volume for EUR/USD

Many say EUR/USD is the most liquid instrument in the world. However, its quote/order volume [1] is probably very different in different order books.

EBS probably receive fewer orders but minimum $10mio. Big banks only trade large orders between each other.

Institutional ECN's like hotspot and FXall probably receive more (tends of thousands) orders usually between 1 to 5mio. Institutional orders are fairly large.

Retail investors send orders too, but minimum $10,000. Therefore volume is much larger.

[1] Note quote and order are slight different. For example, Hostpot lets you send market orders, limit orders etc that are executable. In contrast, Quotes are usually indications.

## common FX arbitrage scenarios

As in other financial markets (FI, options, forwards…), arbitrage is probably #1 force at play constraining public quoted prices. In FX, there are a couple of major arbitrage scenarios, and each is extremely important to real world pricing algorithms

* tri-arb (total 6 bid/ask numbers on 3 currency pairs)
* Int Rate Parity. See [[Complete guide]]
* arb between FX futures and spot markets. Bear Sterns used to do these arbitrage trades.

IRP is at the heart of forward point calculations.

IRP is the crucial link between the money market and FX forward market prices.

Tri-arb is at the heart of cross rate derivation.

How about fx options quoted on AB, AC and BC? I believe there are arb-constraints on the quotes.

Database tables to facilitate cross rate generation

has some details.)

Since the same EUR/USD bid/ask can be published by multiple ECN's,  we needed a

  QuoteSourceID — either an ECN or a market maker's ID
  Symbol char(6) — exactly 6 characters
  SSID — identity column

Based on this mapping, we need a

  CrossSymbol char(6)
  SSID2 — These 2 rows refer to the 4 numbers sufficient to price the
CrossSymbol in question
  VehicleCurrency char(3) — either USD or EUR
  Formula — only a few combination

With this set-up, the same cross symbol AAABBB can appear many times
in this table because I can price AAABBB bid/ask using

USDAAA b/a USDBBB b/a from Currenex (4 numbers)
EURAAA b/a BBBEUR b/a from Currenex (4 numbers)
USDAAA b/a USDBBB b/a from Hotspot (4 numbers)
EURAAA b/a BBBEUR b/a from Hotspot (4 numbers)

So which of these algorithms should I use? I feel we need to use all
of them and select the safest bid and safest offer for AAABBB symbol.

FX trading volume by hedge funds

passive trading (i.e. posting a bid or offer) and active trading (i.e.
hitting a bid or offer).

hedge funds and CTAs trade FX speculatively to a greater extent than
any other type of buy-side institution. most hedge funds trade FX
electronically on one or more multidealer-to-client platforms. The
leaders in this space remain Currenex, FX Connect, FXAll, and Hotspot

(like tradeweb for bonds?)

Hotspot in 2006 did 5-10k trades/day. Hedge funds and CTAs account for
approximately 80 percent of Hotspot's volumes. The balance is composed
of asset managers, large-volume corporates, and small, nonmarket maker
banks. The platform trades only forex spot, and supports 24 currency
pairs. Buy-side to buy-side trading accounts for up to 45% of all
trade volumes.

Hotspot in 2011 trade about USD 60b notional. Hotspot trades are
exclusively institutional, so minimum lot size is probably 1m or 10m.
About 5,000 – 50,000 trades a day.

[11] real time high volume FX quote processing #letter

Horizontal scale-out (distributing to different boxes) is the design of choice when we are cpu-bound. For instance, if we get hundreds of updates a sec and each update requires repricing a large number of objects.

Ideally, you would want cpu to be saturated. (By using twice the hardware threads, you want throughput to double.) Our pricing engine didn’t have that much cpu load, so we didn’t scale out to more than a few boxes.

The complication of scale-out is, data required to reprice one object may reside in different boxes. People try many solutions like memory virtualization (non-trivial synchronization cost + network latency), message-passing, RMI, … but I personally prefer the one-big machine approach. Throw in 16 (or 128) processors, each with say 4 to 8 hardware threads, run 64-bit, throw in 256G RAM. No network latency. No RMI/messaging latency. I think this hardware is rather costly. Total cost of 8 smaller machines with a comparable total CPU power would cost much less, so most big banks prefer it – so-called grid computing.

According to my observations, most practitioners in your type of situations eventually opt for scale-out.

It sounds like after routing a message, your “worker” process has all it needs in its local memory. That would be an ideal use case for parallel processing.

I don’t know if FX spot real time pricing is that ideal. Specifically, suppose a worker process is *dedicated* to update and publish eur/usd spot quote. I know you would listen to the eurusd quotes from all liquidity providers, but do you also need to watch usd/jpy and eur/jpy?

interesting jargon in FX swap # !! ccy swap

What does it mean if you “buy and sell GBP 5 million against USD in a 1-month (30 days) FX swap”?

It means you buy GBP now, using USD (as collateral?), and in a month sell it back with interest, and get back USD.

Note you must arrange to sell back more than 5mil GBP, otherwise, you end up holding some amount of interest in a foreign currency (GBP), with an unknown market value when reporting in home currency (USD). This is commonly seen as a FX risk.

counterparty reference table

TblCounterParty is a typical static reference table in any trading system.
Usage: generate confirms.
Usage: Counterparty is needed to generate “settlement instructions”, as Jinwen pointed out.

An interesting complexity occurred with a “parent company” in the counterparty table. This row in the table has “associated counterparties” ie sub-entities. (The TblCounterparty table is actually hierarchical.) In this case, the actual counterparty is a sub, but the eager trader didn’t take down the particulars of her counterparty. Unable to decide what specific counterparty to enter on the trade, and unable to use the parent company, she used a “dummy” counterparty, hoping the actual identity would transpire. But it didn’t. The sub-entity is untraceable. Trade had to be cancelled.

fx pairs – 4 + 3

the seven most liquid currency pairs in the world, which are the four “majors”:
and the three commodity pairs:

  • EUR/USD (euro/dollar)
  • USD/JPY (dollar/Japanese yen)
  • GBP/USD (British pound/dollar)
  • USD/CHF (dollar/Swiss franc)

  • AUD/USD (Australian dollar/dollar)
  • USD/CAD (dollar/Canadian dollar)
  • NZD/USD (New Zealand dollar/dollar)

Read more: currency pairs, along with their various combinations (such as EUR/JPY, GBP/JPY and EUR/GBP), account for more than 95% of all speculative trading in

FX/Eq trade && notional daily volume – 2011 statistics

2011 – Morgan … FX spot + futures is about 100k – 200k trades
2011 – BA FX everything is about 50k trades
2011 – Hotspot FX spot is between 10k to 100k trades. Average Notional USD 66b
2011 – Another ECN I know does tens of thousands of trades a day in FX spot. Average Notional USD 11b
2011 – A big European bank’s Equities desks – about 500mil orders a day. 50 microsec/order
2011 – another big European bank’s Equities (mostly cash but also fut/op) – about 1 – 3 mil orders executed/day, typically with 2 fills for each client order.

rho of a vanilla fx option

(See post on theoretical greeks)

For equity options, it’s known that rho is a relatively insignificant sensitivity compared to the big 4 greeks. I know FX rates are sensitive to the 2 interest rates involved. What’s the rho of a FX option?
A: insignificant.

where :
From FX-modified BS formula, we can tell rho is equally insignificant for equities vs forex.  However, a 10bps bump in either rd or rf will immediately(?) affect S, more in forex than in equities. I believe an rate hike makes a currency attractive at least in the short term
Answer: (from a young FX quant) even though spot forex rate S0 is influenced (less than fwd forex rate) by  rd or rf, we still assume S0 is an independent variable when we bump rd or rf. There’s no mathematical justification to adjust S0 when we bump the rates. Therefore for short dated FX options, rho is insignificant.

fxoption vs eq-option popularity among non-retail traders

I spoke to a market data vendor’s presales. Let’s just say it’s a lady named AA.

Without referring to the Singapore market, she feels FXO is clearly more popular as a hedging tool than EqOptions. I feel that’s true among her clients (all institutional, no retail). She explains that only large equity funds would use eqo while virtually all importer/exporters would buy fxo (usually from banks). I asked “In that case how do the equity traders hedge their risk if Not with options?” She didn’t give a complete answer but cited eq index and futures.

I too feel import/export corporates outnumber equity trading houses (perhaps by a large margin), but I feel eqo is more liquid (thanks to exchanges) and more widespread than fxo. Also, eqo has retail demand.

Our conversation about fxo vs eqo was exclusively focused on the hedging usage. Eqo has other users including traders. I was told some hedge funds also trade fxo, but I feel it’s less popular due to exchanges and bid/ask spread.

She felt FXO must be on the books of every corporate (treasury). I asked why. In terms of FX risk hedging, she feels option is the true hedge, whereas fwd is a view on the market. I guess there’s some deeper meaning in her remark. Perhaps she means option is an insurance.

risk reversal represents … skew sentiment

RR (risk reversal) is a quantitative indication of skew. As a key soft mkt datum, it focuses on and expresses a specific aspect of market sentiment. A lot of raw market data distill into this one number.

See P 118 [[FX analysis and trading]] (Bloomberg Press) — Positive RR represents bullish sentiment because call i-vol (surge-insurance premium) is higher than the comparable put i-vol (sink-insurance premium). That means more insurers feel surge is more likely than sink. Here we assume just 2 risks exist in this simplified world — surge and sink.

Another source says positive risk reversal implies a skewed distribution of expected spot returns composed of a relatively large number of small down moves and a relatively small number of large upmoves. But I find this statement ambiguous.

Note for equities, put i-vol always exceeds call i-vol, so skew is always negative. See other blogs.

In a wider context, there exists a wide range of transformations (and extractions) on raw data including historical, economic and issuer data. Techniques vary between markets. Even between 2 players on the same market the techniques can vary widely. There are entire professions dedicated to data analysis — quant strategists and quant analysts and quant traders. Among data transformations, RR is one of the most essential and part of the industry-standard.

FX dollar amount per trade

For a large FX ECN, USD 1 – 5 mio. “99% of trades are below 5 mio. A big trade should be sliced up to minimize market impact.” says — The minimum transaction size of that can be dealt on EBS/Reuters tends to one million of the base currency. The average one-ticket transaction size tends to five million of the base currency. What would be an extremely large trading amount (remember this is unleveraged) is the bare minimum quote that banks are willing to give – and this is only for clients that trade between $10 million and $100 million and just need to clear up some loose change on their books.

USD 10 mio for institutional (client) trades in a big bank.

FX spot – voice trading still happening

“even though online foreign exchange trading is available, many of the large clients who deal anywhere from $10 million to $100 million at a time (cash on cash), believe that they can get better pricing dealing over the phone than over the trading platform. This is because most platforms offered by banks will have a trading size limit because the dealer wants to make sure that it is able to offset the risk.”

low delta always means OTM, intuitively

(Low delta means low absolute magnitude. The sign of delta is a separate feature.)

The more OTM, the less sensitive to underlier moves — low delta.

The more ITM, the more stock-like — high delta. This holds for both calls and puts.

For a call holder, the most stock-like is a delta of 100%
For a put holder, the most stock-like is a delta of -100% i.e. a short stock

For a put Writer, the most stock-like is a delta of +100% i.e. long stock. This put is so deep ITM it will certainly be exercised (unload/put to the Writer), so the put writer effectively owns the underlier.

On FX vol smile curve, people quote prices at low-strike points and high strike points both using low deltas like 25 delta or 10 delta. (The 50 delta point is ATM).

– On the low-strike side, they use an OTM Put. Eg a put on USD/JPY struck@55. Such a put is clearly OTM since as of today option holder will not “unload” her USD (the silver) at a dirt cheap price of 55 yen.

– On the high-strike side, they use an OTM Call. Eg a call on USD/JPY @140. Such a call is clearly OTM, since as of today option holder will not buy (“call in”) USD (the silver) at a sky high price of 120 yen.

short term influences on FX rate – ML perspective

* (Above all, IR has the most direct impact on FX rate, at least in the short/mid term.)

* Positions in the FX futures and options market — For eg, high volumes around contract expiry dates can move FX rates
* Activities in the FX options market — for eg, large orders as a result of option excise can move spot prices.
* Fund manager activities — they can move in/out of Euro zone or America. Look at international portfolio managers, not small investors. If these managers want to trade and hedge globally and diversify the portfolio, then they need to invest not only in the domestic market but markets denominated in other currencies. They need FX as a means to an end. They must pay the FX transaction fee. In this sense, I believe FX importance and value-add is smaller than Eq and FI, but it does grow.
* Stock market — a country’s currency rises with its stock market
* commodity prices

Which of the 2 quote prices (bid/ask) can I get@@ An easy rule

When working out pricing scenarios, always remember there’s the bid and ask; always remember whether you are market maker or taker.
* only the dealer can buy low sell high
* both dealer and client can trade with another dealer by accepting the inferior prices.

Say you see a quote for a commodity like silver at 1.2345/47. Treat the base currency as a base/precious metal like Silver or Gold (strictly qualifies as Commodity). Clearly the market maker is bidding at the lower 1.2345 price and offering at the higher 1.2347 price.

   Market makers always want to buy-low, sell-high

You can’t do that, because you are market taker. Market takers have to buy-high, sell-low. More simply,

  Client get the worse of the 2 prices quoted.

This is so that the market maker can make a profit to cover her risk/cost of making the market. If client take the other price, then it would be a free lunch for all.

* if clients buy, clients buy at the higher (worse) of the 2 price quoted
* if clients sell, clients sell at the lower (worse) of the 2 price quoted

This Easy Rule is relevant in FX, commodities, stocks, futures, IRS, bonds..

Now, after a dealer gets a position (say long  EUR, short  USD), she could close it by calling another market-maker, but giving up her market-making advantage and accepting the worse prices proposed by the counter dealer. The better alternative for her is price shading. This way she still enjoys her market-maker advantage.

currenex usage in a FX dealer bank

The bank utilizes currenex as a generic infrastructure to build a private ECN, so they can stream their customized live quotes to their private clients. No data is public.

I know this private ECN supports quote dissemination (“advertising”). Not sure about other functionalities.

value-dates of T/N + common FX fwd deals

(Suppose today is Monday.)
T/N (tom/next): near (value) date is tomorrow, far (value) date is the-day-after, meaning Wed. Wed is actually today + 2 biz day = T+2. Wed is actually the standard “spot-value-date” of Monday. All spot trades (except CAD) on Mon uses Wed as spot-value-date.
S/N (spot/next): near (value) date is spot value date (T + 2!!), far (value) date is the day after, meaning Thu

O/N (overnight): near (value) date is today, far (value) date is tomorrow ! Unbelievable? See below

Note the standard value-date of a standard Monday spot trade is Wed but T/N and O/N Forward outright deals are deals “for value before spot” with value-dates before Wed. The quote convention is special. Here’s the reasoning.

) Suppose T/N points are quoted lower/higher like “EUR/USD T/N outright 0.56/0.58“, then we know for sure base currency (EUR) is rising.
) We also know that the trend is 100% sure to continue for the next 2 biz days thanks to interest rate differential.
) We know that base currency will appreciate from value tomorrow to value spot. Note Monday’s spot-value-date is Wed.
) Spot quotes (value T+2 i.e. value Wed) are available everywhere. T/N forward outright quote is always computed based on spot rates i.e. value T+2 rates. Therefore in our example EUR “value tomorrow” is cheaper than EUR “value spot” i.e. value Wed. We need to __subtract__ the forward points from spot quotes
) If value spot (actually value Wed) E/U is 1.2345/1.2347, then E/U value tomorrow is computed as 1.2345-0.000058/1.2347-0.000056. When subtracting, always subtract more from the bid.

+ If you deal T/N forward outright on a Thu, then the transaction would be “value Friday”, i.e. value date of the transaction is Friday. Is there’s a far-date in a forward outright deal? I don’t think so.
+ If you deal T/N FX swap on Thu, then the near value-date would be tomorrow (Friday), and the far value-date Monday

non-trivial FX jargon

? customer order vs non-customer order
bank stream
executable quote
Non-deliverable forwards
repo vs FX swap vs currency swap (x-currency IRS)
rolling forward
T/N, O/N, S/N
run-through (forwards market)
direct quotation, indirect quotation —
institutional client vs corporate client
banks vs dealers
volatility smile/skew in FX vs equities
relation between Libor rates and FX forward rates
difference between cross-currency IRS and regular IRS

liquidity providers — dealer banks and some hedge funds. Liquidity consumers include small banks and corporations.

relationship-based vs anonymous dealing platforms — Reuters conversational dealing — 2 counter-parties know the identity of other. Note EBS is anonymous. FXAll started as purely relationship-based, later added anonymous platform.

FX pricer #1 short-term driver — 2 IR of the ccy pair

(See also blog on forward FX rate formula.)

For both spot dealer and forward dealer (see separate blog post), interest rates (both short and long term IR, both spot IR and forward IR) are the most important input. Unlike a buy-side (HF…) trader, a dealer typically gets a lot of RFQ during the day and must watch the live interest rates.

Beside IR, All the other inputs to FX pricing engines are probably for different purposes.

A veteran once told me “FX involve 2 interest rates; equity involves dividends. Roughly equal in complexity” but I believe eq options are more complex, involving volatility, repo (supposed to compensate for PCP imperfections?) in additional to IR + dividend. gave 6 factors affecting FX rates. I feel interest rate is the only short term live market data.

3 basic value-add in the ECN business model

An FX dealer bank’s system usually interfaces with EBS, Reuters, Bloomberg, FXAll, Currenex, Hotspot … Between any 2 of these, there’re often competing features.

Feature 1: execution. order forwarding to dealers. Actual execution is at the dealer bank after the Last-Look.
 Remember TMS and FXAll.

I feel execution is the #1 (but not the only[3]) value-add of ECN. A slow ECN can also aggregate a lot of quotes. If no client find the quotes competitive then no trade.

[3] Execution isn’t the only value-add. In this huge ecosystem, there are many players selling nothing but data — evaluation prices, recommendations, research, news feed

Feature 2: quote aggregation. depth of market. This service can be “sold” by itself. Quotes have to be fast to be useful.

2b: enable 2-sided market makers to size up a market and then make a market. If the ECN doesn’t offer execution, then clients can contact the market maker directly, just like how I use
2c: price discovery

Feature 3: RFQ, RFS(stream)

FX – no clearing house, no comm says

Currency trading is not done on a regulated exchange (for example: the NYSE). There is also no central governing body (such as the SEC), there is no clearing house to guarantee the trade. Trading currency is done through credit agreements.

By contrast, In stock, option or futures *traders(like Michael Douglas)* typically use a __broker(Charlie Sheen)__ to execute the transaction as per the trader’s instructions. The broker then gets a commission. No such comm in FX! I guess “never” is too broad — there could be minor exceptions. says

If an investor wanted to purchase stocks, /options/, or futures – they would need to ultimately go through some sort of regulated exchange – such as the NYSE. Currency traders (except CME fx futures) have no such regulated mechanism overseeing transactions. What exactly does this mean for the average investor? – An increased element of risk.

There are no commissions in FX trading! This is possible because there are no brokers – only FX dealers.

top 3 subsystems ] spot (and forward) FX dearler bank

There are 3 types of FX dealers – spot dealer, forwards dealer and (corporate)client-facing sales dealers covering spot and forward. They use the systems below differently.

Note ONLY the sales dealers would interface with clients (no retail client). Spot/Forwards dealers deal with sales dealers and counterparty dealers.

#1))) Heart of entire FX desk is the “position keeping system” or position-master. All “deals” are stored there, so as to “calculate current positions” and PnL. Same idea as MTS inventory-mgr and Reo main-grid.

Note sales dealers never keep positions. I believe they are internal brokers on bank’s payroll.

FX position systems usually show real time unrealized P/L.
#2))) AFTER (never before) a dealer executes trades via a voice broker, he needs to record trade details on a “deal-ticket” (see other post) and enter it in the “deal entry system”, just like MTS. Electronically executed trades don’t need this “deal entry system”

Spot trades are too many so seldom voice-based. Forwards dealers use voice brokers more often. Sales dealers do even more voice EXECUTION (often with a customer). These 2 groups definitely need the deal-entry system.

As of 2010, the most common execution model between clients and banks is not ECN (growing) or Reuters conversational dealing, but voice execution.

#3))) (Pending) order management — If a spot dealer wants to hold a position “open” overnight, she must leave a stop loss order. While she’s out, the order is looked after by the take-over time zone (NY -> SG/TK/HK -> London) which MIGHT execute the stop loss order.

Forwards dealers don’t leave overnight orders. Sales dealers often create customer orders for the spot/forwards dealers to execute.

Sales dealers can also create overnight limit orders on behalf of clients.

technologies of citi FX trading

The FX department you applied for gave a presentation. They said the dominant technologies are

· Swing still works but being replaced by C# (WPF, Silverlight)
· Messaging – RV, EMS, multicast (I think he means RV or JMS multicasting)
· Socket programming
· Grid computing
· Sharepoint
· FIX protocol

Compared to muni, I feel FX has more front end UI systems, because FX has a more diverse client base. Muni has no or limited client-facing UI, because muni investors call their financial analysts to trade. In contrast, FX system has a large number of retail customers (using web) and smaller number (700?) of institutional clients including exporters, governments, airlines, manufacturers, commercial banks who often receive and pay out in multiple currencies. These institutional clients get to use a “professional” front end system, swing/WPF, not web-base, even though connection is over internet. Both muni and FX systems have a lot of (20 – 30) intranet UI systems in http or swing.

Risk system takes in current prices (fast changing) and estimates unrealized PnL on the dealer’s book i.e. trading account.

Even if we include FX options (not futures), most FX trading is OTC. CME is listing fx option contracts and some big dealers (like MS) are following. Some instruments (futures..) are guaranteed by exchanges such as CME. In comparison, most muni trading is OTC, since muni is a dealer market, with a few small brokers in between.

FX option – collateral, briefly

A 2008 CFA textbook suggests that most fx options are tailor-made for a given client. Listed fx options trade volume is “fairly low” (2008)

According to Wikipedia, Most of the FX option volume is traded OTC , but a fraction is traded on exchanges like the International Securities Exchange (FX options), Philadelphia Stock Exchange (FX options), or the Chicago Mercantile Exchange (options on FX futures)

I guess one possible reason is – end users (large international organizations who need to convert currencies) don’t like the standardized terms on the exchanges??

Another possible reason is fee??

Most forex option trading is conducted via telephone. There are only a few forex brokers offering online forex option trading platforms.

The same fx option can be viewed as either a call or a put, but the writer is always the writer. Fx option writer (say DB) must put up collateral; fx option buyer must pay the writer an upfront premium. Intuitive for a fx call, but if you see it as a put, the same writer (DB) still has the same collateral/premium deal.

reading FXVol names – simple rules to remember

Confusing rule — a put on AAA/BBB is same as a call on BBB/AAA !

Simple rule: In the beginning, always treat first ccy as commodity and resist the temptation to treat second ccy as commodity. Even though other people tell you about the equivalence, beware the confusion it causes.
Simple rule: on the smile curve or vol surface, use OTM and ATM instruments only. Don’t flip the currency pair.

Simple rule: on the smile curve, you use low low-delta puts and calls, never high-delta instruments, and never flip the pair

Simple rule: option seller is always seller (never becoming buyer) when you convert between an equivalent call and a put. Option seller always collects insurance premium and is always short vega. However, for a RR strategy either counterparty is simultaneously seller+buyer.

2 FX interbank broker ^ 2 interdealer treasury broker

Treasury Inter-dealer brokers are the backbones of treasury market. BrokerTec and Espeed…

FX interbank brokers are the backbones of currency market. In Spot FX, EBS and Reuters (see separate blog) are the only 2 big brokers. See and the investorpedia article. Big banks handle very large transactions often in billions of dollars. These transactions cause the primary movement of currency prices (in the short term?) In the long term, fx is influenced not by the big bank’s actions, but economies.

Reuters’ system for Spot is a the electronic version of traditional voice execution. A screen-based “conversational” system so both sides know each other. Trades execute in the conversation, much like voice execution.

In contrast, EBS is anonymous. Trades execute when market-takers hit a button on screen.

For FX Forward, Reuters (see the other post) is dominant, but Tullet Prebon is popular too.

CIP illustrated

Jargon: “forward-points” are bid/ask quotes. These are added on top of spot quotes
Jargon: full-forward-rates are the bid/ask quotes after the adjustments.
Sound byte: if my currency “drops”, then my interest rate should compensate that.

Q1: Suppose AUD (or USD…) spot interest rate is 200 bps [1] for a 1-year term. Yen spot rate is 150 bps. Suppose spot USDJPY = 100. What can you say about today’s AUDJPY forward rate with far date a year from now?
A1: this is Covered-Interest-Rate-Parity in action. Formula below gives F = 100*1.015/1.02 = 99.5098.

A more basic question is
Q2: will AUDJPY rate rise or fall?

We need to be thoroughly familiar with Q2 — AUD must WEAKEN (to 99.***) to reduce the high AUD return of 200bps!

[1] don’t care about Libor or treasury rate. Just consider it a measurable interest-rate

In practice, the 2 IR, the spot and forward fx rates always follow the equation. convert-deposit == deposit-convert. Otherwise, there will be arbitrage. This is described in both my bank online learning and [[complete guide]]

——textbook eg—–
USD 1 mth IR = 418 bps/year
GBP 1 mth IR = 480 bps/year
Spot cable = 1.7249
Number of days in the month = 31
Days basis GBP = 365
Days basis USD = 360

Let’s calculate 1-mth GBPUSD forward rate.

418 * 31/360 = 35.99444 bps of interest in USD
480 * 31/365 = 40.76712 bps of interest in GBP

Option A: 1 GBP invested today becomes #1.004076712 in a month
Option B: 1 GBP converted to USD and invested today becomes $1.7249 * 1.003599444 = $1.731109. Formula is S*(1+IR)

To make these 2 investments equally appealing to an investor, forward GBPUSD rate must be

1.731109/1.004076712 = 1-mth forward GBP/USD = 1.72408, which represents a depreciation of 8.2 pips.

Intuitively, GBP pays more interest, so GBP must depreciate. If GBP were to appreciate, then it’s too good to be true.

Textbook answer — Forward points = -0.00082

[ Formula is Spot-GBPUSD * (1 + IR-on-USD) == Forward-GBPUSD * (1 + IR-on-GBP)]
[ GBP convert to USD then deposit =========== GBP deposit then convert to USD ]
[ convert then deposit ==================== deposit then convert ]

—– a similar textbook example —–
AUD 3-mth 550 bps (high-yielder)
USD 3-mth 425 bps
Spot AUD/USD = 0.7326
Days = 92
Days basis AUD = 365
Days basis USD = 360
Forward AUD/USD = 0.7626 * (1 + 425 bps/360*92)/(1 + 550 bps/365*92) = 0.730431
Textbook answer — Forward points = -0.002169

interbank broker^ECN, FX or Treasury

FX Interbank broker (EBS or Reuters) is like eSpeed and brokerTec; FX ECN is like tradeweb — connecting big dealers to instituional clients including corporations and fund managers.

Many if not most ECN’s are anonymous, just like EBS (and some Reuters systems). Some large clients may have a relationship with big dealers so they may probably prefer conversational dealing just like Reuters Dealing.
* FXAll’s original system is a relationship based conversational dealing system between dealers and institutional clients.
* 360T offers a relationship-based, non-anonymous platform.

Reuters Dealing 3000 spot/forward are anonymous.

For tradeweb, liquidity providers are primarily large banks. I think FX ECN may have some hedge funds serving as liquidity providers too.

In FX jargons, “market-maker” and “liquidity provider” (also Dealing Desk) generally refers to dealers with inventory. ECN usually means a platform operator forever without position. “Broker” is used very loosely in the FX business and can include any entity except a retail client.

y FX and MM are in one desk

In Citi and ML, FX desk also handles money-market (“local market”) deals. This is largely because that client needs, pricing and operations in both markets (FX forward and MM) have always been closely linked and inter-dependent [1] for hundreds of years.

I believe Money market means short-term lending market. Usually up to 12 months.

[1] Personally I feel it’s more of a one-way dependency, rather than mutual-dependency. Every client with regular FX transactions has periodic, predictable FX needs in the near future. FX forwards always, always involves (short-term usually) interest rates.

"yours/mine" in FX spot trading room

Think of USD as a commodity (like silver or oil) and is quoted in commodity markets

—-One client—-
market-maker: USD/CHF 96/99 ## MM is bidding silver at 1.2196 and offering silver at 1.2199
market-taker1: “Yours” ## market-taker1 hit and sold at bid price. MT1 declaring “silver is now yours
MM: given at 96 ## “we are given the silver” at 1.2196 CHF
—Another client—-
MM: USD/CHF 96/99
MT2: “Mine” ## market-taker2 lifted and bought at offer price. MT2 declaring “the silver is now mine
MM: 99 paid ## “we are paid 1.2199 CHF” for selling our silver
In each case, the last announcement by MM is to his boss and colleagues (NOT to market-taker) so they can feel the buzz.
– If boss hears repeated “given” she knows this silver (base currency) is under heavy selling by clients.
– If boss hears repeated “paid” she knows many customers are buying (paying for) the silver ie base currency.

Whoever giving the quote is the market-maker. Whoever saying “yours” or “mine” is the market-taker, who can be another dealer bank.

real time PnL in FX spot (and forward) trading

The position master (heart of spot trading platform) marks all positions in real time through the day, but at 4pm it closes the book and marks all open positions one last time and computes unrealized PnL and realized PnL for the day.

Same as Reo.

In spot FX, most positions are “flat”, at any time, there are a small number of non-flat positions. These jargons all refer to the same concept and are the subject of marking and unrealized PnL report.
– “current position”,
– “open position”,
– open trades

Note In forward FX, marking is done with live forward prices, not spot prices.

multiple PnL currencies in 1 FX trading account

(For large banks, see other blog)
Q: how and why would a system maintain 2 pnl reporting currencies in a single fx trading account?
Be it client accounts maintained at a sell-side dealer or sell side trader accounts, in most cases there’s probably good reason to consolidate all open positions into a single reporting currency. However, I think there are important exceptions.

One possible exception is house account handover, say from NY to Tokyo. It might make sense to have a book using both USD and JPY as reporting currencies, so NY open positions can be handed over Tokyo.
Here’s another exception.

Based on
You sell (go short) USD/JPY and as such are short USD and Long (bought) JPY. You enter the trade at 116.10 and exit 116.90. You in fact made 80,000 Japanese Yen (1 lot traded) not US Dollars.
If you traded all four major currencies against the US Dollar you would in fact have made or lost in EUR, GPY, JPY and CHF. This might give you a ledger balance at the end of the day or month with four different currencies.

This is common in London. They will __stay__ in that currency until you instruct the broker to exchange the currencies into your own base currency. Most US based (retail) traders assume they will see their balance at the end of each day in US Dollars.

OMS in FX vs equities

OMS is often the biggest and the core module in any trading platform that supports pending orders and FIX execution.

What are the differences between an eq OMS (see [[Complete Guide]]) and an FX OMS?

FX is fundamentally OTC and quote-driven, not order driven as listed markets are.

Q: in FX, there’s no exchange making the (irrevocable) matching?

Affirm^Confirm in FX drv

In both FX derivativies and Equity derivatives worlds, there’s a Affirmation process before the Confirm process. We will focus on FX derivatives but most of it applies to eq derivatives.

Confirm is a legally binding document, accessible by clients, often on paper. Affirm is not legally binding. It’s often based on a phone call between the 2 counterparties. Think of Affirm as a preliminary Confirm.

Q: can we (operations) complete Affirm on a trade without checking with counterparty?
AA: Forbidden. Operations must verify with counterparty before completing Affirm.

Given its legal power, it’s good to know what a confirm document contains. A BofA veteran told me it might say “Blackrock shall pay BofA $1m on 1/1/2013”. There are 2 such confirms, on both sides, to be matched.

For a derivative deal executed on T+0 and settles T + 3mth, Affirmation could happen T + 0/1/2, but Confirmation usually happens right before T + 3mth — real world settlement. Settlement system actually receives the trade around T + 0/1/2, but keeps the trade as unsettled and often reports such unsettled trades on a daily basis.

math learning curve in FX business

In FX business (not saying “system”) , most of the initial learning obstacles are math-related. A large part of it is due to the need to forecast fx rates. “Hedge” and “risk” are all about uncertainty in FX rate movements.

To avoid confusion, in this blog we don’t really talk about FX Futures contracts at all. “Future” doesn’t mean “Futures contract”.

If you as an enterprise just needs to convert currency at the spot rate, it’s straightforward. But any solution to future-proof your corporate FX needs tends to involve derivatives tied to future FX rates. Incidentally, every derivative (forwards, options, swaps ..) has an expiration date.

Whenever you consider future FX rates, the 2 countries’ interest rates come into play. I feel the Interest-Rate-Parity formula is quite basic and unavoidable, just like PCP and price/yield conversion. Other obstacles include
– Cross rate calc
– triangular arbitrage

FX settlement system

I once interfaced with the FX settlement (clearance) system of a major US bank (let’s call it CB). There are always 2 counterparties to each trade. Each counterparty has a nostro account with an “clearance bank” [1]. The settlement process must transfer one currency from clearance bank acct A to clearance bank acct B, and transfer the other currency from B to A.

For example, JPM could be a counter party, but for one particular FX trade, the HKD clearance bank could be HSBC in Hongkong.

In our case, one of the 2 clearance banks is always CB itself. In fact one of the 2 counter parties is usually a CB-controlled trading account.

The settlement system is also know as “cash manager”.

[1] For example nostro acct to receive HKD must exist in a HK bank — the nostro bank. Only HK banks can be the clearance bank for HKD. In the special case of Euro, nostro acct can be in any Eurozone country.

FX fwd outright^swap, rolling fwd, repo…briefly

There are 2 instruments in FX forward. Forward outright is among the simplest types of financial forward contracts. You actually exchange (like going through the money-changer exactly once) the 2 amounts on a future date. This instrument is not tradable.

(An alternative form of outright is NDF, common for Chinese RMB. Money-changer 0 times i.e. never. It’s a cash-settled derivative just like FRA or IRS.)

The more complex forward instrument is the FX swap (I don’t mean “currency swap”, which is basically IRS). Tradable on interbank market. Money-Changer 2 times, on Near date and Far date. To understand the Need for FX swap, we need to understand rolling forward….

FX swap is like a repo — 2 legs, 2 settlement dates.

Important jargon/concepts in FX forward
* near date, far date
* near leg (usually “spot leg”), forward leg

Most FX forward contracts have a timeline of 1 to 12 months from trade date. Same for FX options.

deal ticket of a FX deal #ML

Whether a FX spot/forward trade is executed electronically or over phone, trade details must be recorded on a “deal-ticket” and entered into the position master. Deal-ticket contains

Rate — can be derived from BuyAmt and SellAmt)
ValueDate — usually T+2

CurrencyHoliday DB table

To my surprise, there’s actually a CurrencyHoliday table in the FX trading system. Traders/dealers are alerted to holidays that impact their trade’s settlement.

FX Forward traders get a calendar automatically adjusted based on this table, to show the value dates of T/N, S/N, 1m, 2m etc

The related TblCurrencyPair table holds standard lot size and settlement convension (like T+1 for CAD)

domestic ccy, base ccy… jargons

Key is to view first symbol NOT as a currency but as an asset. Perhaps the best example — “XAG/CC1” means 1 ounce of silver quoted in your local currency CC1.

Asset currency” — Silver is the asset being quoted.
“Commodity currency” — ditto
“Base currency” — (Base-metal) is like the silver prices quoted on exchanges.
“Unit currency” — exactly 1.0 unit of this currency is quoted in the “contract”. This is the currency that’s not changing in the equation like
1 USD = 1.234 SGD, becoming
1 USD = 1.235 SGD

An author said “first currency is like stock in equity market”.
Tony pointed out the graph of CC1CC2 shows the strength of CC1 i.e. one unit of CC1 as a commodity. When CC1CC2 drops we intuitively see CC1 as weakening.

–Above are names of the first symbol; Below are names of the 2nd symbol–

“Domestic currency” — means the currency you PAY to own the silver “asset“. See warning below.
“Quote currency” — means our silver is quoted-in this currency.
“Term currency” — means the exchange rate is quoted-in Terms of this currency
“Premium currency” — means the FX option premium is quoted-in this currency

Starting from a USD inventory,
– When you buy EURUSD, you buy euro, at pip price of 1.4444
– When you sell EURUSD, you sell euro, at price of 1.4444
– When you buy USDJPY, you SELL yen (and buy USD) at 99.99

=== warning Foreign currency is like the Silver. You quote prices in amount of local currency. This terminology is common in literature, but I find it confusing. Inside the United States, USDJPY is traded with JPY as domestic currency!

=== first currency (i.e. base currency) is like the “silver” that you buy or sell.
pip (percentage in point) is expressed-in quote-currency. If USD/SGD is moving from 1.1234 + 1 pip to 1.1235, then that 1 pip means 1 tiny “piece” of SGD.

“Base currency” means? The currency that’s not changing in the equation like
1 USD = 1.1234 SGD, becoming
1 USD = 1.1235 SGD

If you see “2.23 DEM/GBP” price, think of it as
2.23 DEM=GBP or
2.23 DEM/GBP =1   i.e.
2.23 = GBP/DEM 

DB tables]FX cash trading system(any bank

Q999: database tables that are the biggest or busiest

A: see blog on Currency Tables and SymbolSourceMapping tables to compute safe crosses.
A999 from ZJW and Piroz
– Trade table,
– Order table –limit orders are pending and have a lifetime. Also, London traders often need to hand over overnight orders to NY, either mandatory stop-loss-orders or unfilled customer orders.
– A family of RFQ tables like my bidans/bidstreet/bidreq tables.
– IncomingQuote table is (according to ZJW) the biggest and busiest, but there’s probably a separate table for each quote source.
– OutgoingQuote table ??
– ClientPosition table has a primary key on (ClientAcct, Currency)
– TraderPosition table is the mos interesting. Even though there could be a small number of trader accounts, I was told it’s unlikely that system maintains a separate table for each account. Primary key would be (TraderAcct, Currency). In cash trading, most positions are flat i.e. closed out quickly, so there should be relatively few rows in this table. However, if base currency is USD, then a particular trader’s JPY row would get a lot of concurrent updates. Since this row represents real inventory, all updates must follow strict ACID transaction rule. Possibly a bottleneck just like in bond trading.

Q: Any reference data tables

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