From the April 01, 2012 issue of Futures Magazine • Subscribe!

Building forex volatility strategies

Testing hypotheticals

Prices for currency options trades may be compared to the hypothetical prices shown by Barchart.com. These theoretical prices are based on the Black-Scholes option pricing model for a wide range of put and call strike prices. Barchart.com also shows actual trades and the timing of them at specific strikes. This permits a look at individual trades relative to the hypothetical price curve when the trades were made. Prices are shown with a 10-minute delay.

For example, on Nov. 16, 2011, a trade for March 2012 euro calls at 1.40 strike is priced at 0.0266 at 10:07 a.m. when hypothetical prices for puts and calls are shown for latest options at 10:20 a.m. As explained later, when a smoothed option price curve is computed, the trade at 0.0266 is estimated to be underpriced by approximately $64 compared with the theoretical pricing model.

“March 2012 euro calls” (below) charts variations from published prices. As shown on the lower graph (“Euro option price curve”), the regression model is a close fit to Barchart.com prices, with market prices falling almost on the predicted prices at each strike price. The upper chart contains the variations from the smoothed price curve in dollars instead of option points. Because each option point for euro calls is worth $125,000, the variations are greatly magnified from those along the lower curve.

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