Vanilla FX OTC Options with Saxo Bank

Vanilla FX OTC Options with Saxo Bank

Introduction Saxo Bank s proposition to FX options traders is truly unique. Thanks to the quality and depth of the analytics provided, the width of the product offering, the trading functionalities and the level of service available, Saxo Bank clients have access to a grade of trading capabilities that has up to now been reserved to the professional FX option trader. As the vast majority of traded volumes in FX options are done outside of traditional exchanges, effectively between market makers, the currency options market is said to be an OTC (Over-the-Counter) market. Saxo Bank is a top tier market maker and a major player in the interbank market. This provides Saxo Bank and its clients with access to deep liquidity pools and competitive pricing. In practice, the vast majority of trades done at Saxo Bank are executed without manual intervention and the market making desk is there to provide an added-value service for pricing and execution, if and when needed. This essential facilitation service enables Saxo Bank to provide FX option traders with the best possible trading experience. FX Options at Saxo Bank can be sold and bought, with maturities from 1 day to 1 year, so traders are provided with maximum flexibility to implement their trading strategies and market views. Our FX options follow industry convention and are therefore European-style options, meaning that in-the-money options can only be exercised at expiry. Saxo Bank offers two types of options: Plain Vanilla and Binary Options. This document focuses on Plain Vanilla Options only. 2 VANILLA FX OTC OPTIONS WITH SAXO BANK

Table of Contents Introduction... 2 Product Overview... 4 Unique offering and Key Features... 4 Trade Ticket... 4 Monitoring Open Positions... 5 Automated Trading... 6 Dealing Desk... 7 Orders types and order management... 7 Exercise & Settlement - Choice of Exercise method... 7 Color-coded Trade Ticket... 8 Pricing... 9 Spread... 9 Minimum ticket fee... 9 Minimum trade size / liquidity... 9 The Forex Options Board... 10 Opening the Options Board... 10 Strikes / Maturities on the FX Options Board... 10 The Forex Options Report... 11 Where to find the reports?... 11 What are those reports?... 11 Summary Per Cross... 12 Net Delta by Currency... 13 Summary per position... 13 The Spot Ladder... 14 The Spot / Volatility Grid... 14 Margin Requirement... 15 Delta Margin... 16 Vega Margin... 16 Exception for Bought Options... 17 Stop-out procedures... 18 VANILLA FX OTC OPTIONS WITH SAXO BANK 3

Product Overview Unique offering and Key Features 12+ years of experience in market making OTC FX options Major OTC interbank market participant, hence access to deep pool of liquidity Streaming green prices with high thresholds for automatic execution FX Options Board for easier price discovery Wealth of FX Options analytics made available on tradingfloor.com; retail position ratios, 25-delta Risk Reversals, OTC volume index and market pin risk. Streaming prices in 45 currency pairs, including silver and gold. Plain Vanilla Calls and Puts with European-style expiries Full flexible choice of strikes with maturities from 1day to 1 year Automatic exercise of ITM options with choice of exercise method spot or cash All trades are done on live, two-way quotes Dynamic Bid/Ask spreads reflecting the option s maturity and strike Sophisticated margin calculation method (Delta & Vega margins) FX Options Reports free of charge, for a combined analysis of your spot and options portfolio Trade Ticket Saxo Bank has designed an industry-leading trade ticket to facilitate trading decisions for the currency options trader. As illustrated below, traders have access to the relevant information before entering the trade, all condensed in one snapshot. Whilst this information is essential, option traders need to be able to compare different option strikes and maturities in order to find the best value for their trade ideas. For this purpose Saxo Bank developed its unique Forex Options Board. This tool is described in a subsequent section. 4 VANILLA FX OTC OPTIONS WITH SAXO BANK

Monitoring Open Positions Once a trade has been executed, the parameters of the position are updated in real time. Traders are able to review the details of their individual positions by opening the Open Positions module: Traders are then simply required to click on the icon highlighted in the Open Positions monitor, as per below. Following an example of the Position Summary where the trader holds one option. VANILLA FX OTC OPTIONS WITH SAXO BANK 5

For clients with multiple options positions or portfolios combining FX spot and option positions, Saxo Bank offers advanced analysis tools (FX Options Reports) which are covered in a subsequent section. Automated Trading One of the key features of Saxo Bank s offering is the ability for traders to trade in an automated fashion on the most liquid strikes available at a given point in time. To achieve this, Saxo Bank streams prices continuously up to a maximum notional amount that varies according to the underlying cross under consideration. As for all other OTC products offered by Saxo Bank, streaming prices are shown as Green prices in the trading platforms. A Green price is in effect a firm two-way price offered by Saxo Bank to its clients. Trade executions on these prices are handled automatically without any manual intervention. Auto-execution limits are displayed in the trading platforms under Trading Conditions. For example live quoted tradable prices in green for EURUSD options are streamed through the platforms for up EUR 10,000,000 of notional on short dated options and up to EUR 25,000,000 of notional for longer dated options. 6 VANILLA FX OTC OPTIONS WITH SAXO BANK

Clients can trade a given option on streaming quotes no more than three times in two minutes. If the client does trade three times the same option within that time span, streaming quotes will be suspended automatically for five minutes. The client can still request a quote during the suspension period by clicking on the Live Price hyperlink shown below. Auto-execution limits may be changed without notice under volatile or illiquid market conditions. Dealing Desk The Dealing Desk facilitates trades when the automated execution system is unable to do so. If for example a client s requested size exceeds the auto-execution limit or the client requests a price for an illiquid option, the dealing desk will offer tailor-made quotes in order to provide Saxo Bank s clients with the best possible trading experience. Abnormally volatile market conditions represent another typical situation where the intervention of the dealing desk is warranted. Orders types and order management Clients cannot place orders on FX Options. All trades are executed on live quotes. Exercise & Settlement - Choice of Exercise method Expiry of options is an automatic process at Saxo Bank hence clients do not have to call in to manage the expiry of their options. When entering the trade, the client has the choice of the exercise method that will apply to the specific option in case the option ends up In-The-Money. Options can either be converted to a spot position on the expiry date or simply cash settled. FX Options that are In-The-Money are automatically exercised at 10:00 am New York time (New York cut) on the day of expiry. The Cash exercise method is in effect an automated exit of the spot position and is executed at mid-price. If the spot exercise method is chosen, the spot position is subject to the usual profit/loss as the spot price moves from the exercise price. If the client already owns an offsetting position at the time of exercise, the exercised position will be netted out on the following day. The exercise method can be amended by the client up to one hour before exercise. In order to change the exercise method the client goes to Open Positions module and right clicks over the desired position before choosing the Change exercise method menu item as described below: VANILLA FX OTC OPTIONS WITH SAXO BANK 7

Color-coded Trade Ticket The trade tickets in the platforms are color coded to indicate the availability of the price quoted: Green prices are those available for auto-execution. Yellow prices are those where a request for quote (RFQ) is required from the dealers. Purple prices typically mean the market is closed or pricing is unreliable. 8 VANILLA FX OTC OPTIONS WITH SAXO BANK

Pricing The pricing model Saxo Bank applies for FX Vanilla Options is based on the Black-Scholes model adapted for FX Options (Garman-Kohlhagen). Spreads The spread is defined as the distance between the bid price and the ask price. Spreads are variable depending on maturity and currency pair. Minimum ticket fee Small trade sizes incur a Minimum Ticket Fee of USD10 or equivalent. A small trade that attracts a minimum ticket fee is any trade below the Ticket Fee Threshold as per below: Minimum trade size / liquidity The minimum trade size is 10,000 units of base currency. Market orders up to 25,000,000 units of base currency (for EURUSD) will be executed automatically online on live streaming prices. RFQs on amounts above this will be executed manually by the FX Trading Desk. Minimum trade sizes are as follows: XAU/USD: 10 Oz XAG/USD: 100 Oz NOK/SEK 50,000 NOK All others: 10,000 units of base currency Please note that maximum streaming amounts are subject to change without prior notice. FX Vanilla Option Ticket Fee Threshold XAUUSD 50 XAGUSD 5,000 AUDSGD, EURCZK, EURHUF, EURPLN, EURTRY, EURUSD, GBPAUD, GBPCAD, GBPCHF, GBPJPY, GBPUSD, USDCAD USDCHF, USDHUF, USDILS, USDJPY, USDMXN, USDPLN, USDSGD, USDTRY, USDZAR, USDRUB, EURRUB AUDJPY, AUDNZD, AUDUSD, CADJPY, CHFJPY, EURAUD, EURCAD, EURCHF, EURGBP, EURJPY, EURNOK, EURNZD, EURSEK, NZDJPY, NZDUSD, USDNOK, USDSEK 50,000 100,000 NOKSEK 1,000,000 VANILLA FX OTC OPTIONS WITH SAXO BANK 9

The Forex Options Board In order to facilitate the process of price discovery for the trader, Saxo Bank developed a unique proprietary tool called the Forex Options Board. In other words, when a trader has an idea he wants to implement, the Forex Options Board enable him to view the impact of the time value and the level of the strike on the Premium to be paid (long position) or to be received (short position). The Forex Options Board is an essential tool in an FX Option trader s arsenal. Opening the Options Board Strikes / Maturities on the FX Options Board Saxo Bank shows a maximum of 8 standard expiry dates ranging from 1 week up to 6 months. These expiry dates are on Wednesdays and follow the below schedule: 1 weekly contracts 2 bi-weekly contracts 2 four-weekly contracts 1 eight-weekly contract 10 VANILLA FX OTC OPTIONS WITH SAXO BANK

The Forex Options Report Saxo Bank has built a professional-grade set of reports that provide a detailed analysis of the trader s FX and FX Options positions across multiple currency pairs. The reports offer invaluable information for anyone taking a portfolio-based approach to trading. They allow the astute investor to efficiently manage his/her risk exposure and efficiently reflect their market view. Where to find the reports? The FX Options reports are available in the Client Station under the Account tab as shown below: What are those reports? The reports are designed to show exposure to various factors under different scenario. The data is aggregated per currency pair, per currency itself or by individual position. Reports will be available if the client has at least one open vanilla option and will include both the FX Spot positions and FX Options positions. (Binary Touch Options are NOT included). Assume we currently hold the below positions: VANILLA FX OTC OPTIONS WITH SAXO BANK 11

Summary Per Cross Cross Spot Value (EUR) Delta (Ccy1) Gamma (Ccy1) Vega (Ccy2) Theta (Ccy2) No. of Positions EURUSD 1.2940-2,028 522,388 161,825 999-221 4 USDCHF 0.9437 9,196-50,000 0 0 0 1 This table aggregates all the positions per currency pair, and shows a global view of one s risk in each pair. For instance, we can see that the EURUSD portfolio is comprised of 4 positions (Note: the short call position was traded in two lots). Value: shows the amount an option is worth. Shows a positive number if you are long and a negative one if you are short. For Spot, this shows how much the position is in profit or loss. Delta: Shows the equivalent FX Spot exposure of a given position. This is the sensitivity of a position s value with respect to the spot rate. In the above table, we can see that the overall position in EURUSD behaves as if it was long 522,388 EURUSD spot: if EURUSD spot moves 1 pip up, the portfolio s value would increase by USD 52.2. Gamma: This is the second derivative of the position value with respect to spot, i.e. it shows how much the delta changes when spot changes (i.e. how much will the delta change when spot moves up by 1%). Vega: Sensitivity of a position with respect to the implied volatility used to price FX Options. This shows how much money is made (positive number) or lost (negative number) when volatility goes up 1%... from say 12.5% to 13.5%. In our example, we see a positive Vega of USD 999 in EURUSD, meaning that the position s value will increase by this amount should volatility rise by 1%. This amount would be lost if EURUSD implied volatilities were to go down by 1%. Theta: Also known as time decay. This shows by how much the position will increase or decrease in value from one day to the next. In the above example, and all other things being equal, we can see a decrease in value of USD 221 for the EURUSD positions for one calendar day. Note: Since changes in interest rates typically do not pose as great a risk to option traders as Delta, Gamma, Theta, and Vega risks, Rho and Psi were intentionally left out of the reports. 12 VANILLA FX OTC OPTIONS WITH SAXO BANK

Net Delta by Currency Cross Delta No. of Positions CHF 47,215 1 EUR 510,854 4 USD -710,585 5 This table shows the delta, but this time netted per currency rather than currency pairs. This is very useful to see triangulation risks, and to identify which cross a portfolio is most exposed to. Summary per position Position ID Direction Amount Cross Strategy Strike Expiry Value Value (EUR) Delta (Ccy1) Gamma (Ccy1) Vega (Ccy2) Theta (Ccy2) 51050279 Sell 50,000 USDCHF FX 1.1683-11,201 9,173-50,000 - - - 460933124 Sell 100,000 EURUSD Call 1.4000 17 Apr 2013 0 0-640 -91 - - 460933126 Sell 1,000,000 EURUSD Call 1.4000 17 Apr 2013-5 -4-640 -912-8 1 463122133 Buy 250,000 EURUSD FX 1.3220 - -7,230-5,591 250,000 - - - 466043669 Buy 1,000,000 EURUSD Call 1.3105 08 Apr 2013 4,129 3,193 261,558 159,685 984-216 The summary page displays a table showing the market sensitivities per individual position. Although this might seem a little redundant with the other tables, this is actually quite useful to identify where a specific exposure comes from. For instance, we can see that our net EURUSD Vega exposure (sensitivity to implied volatility) is mostly coming from our long position in 8th April 2013, 1.3105 EUR calls (last line of the table). As can be seen, this summary page provides a very good snapshot of the portfolio at a given time, and will be very useful to the active trader. VANILLA FX OTC OPTIONS WITH SAXO BANK 13

The Spot Ladder Additionally, the Forex Options Report clarifies the sensitivity of the client s portfolio thanks to the Spot Ladder and the Spot/Volatility Grid. In the snapshot below, it is easy to assess what the sensitivity of the value of the EURUSD portfolio as well as its Greeks is to variations of the Spot rate. The table shows this sensitivity to a 2.5% variation up and down of the spot rate.. Note that the table provides the trader with the possibility of drawing the same table for a +/- 10% variation of the spot rate as well The Spot / Volatility Grid Taking the analysis one step further, the Spot / Volatility Grid provides a similar analysis as the previous report but this time enables the client to see a two dimensional picture of the sensitivity of his portfolio. Hence the trader is able to assess the impact of a variation of +/- 2.5% of the spot rate combined with a variation in volatility of up to +/-2 points of volatility on his portfolio. The table provides both a profit & loss measure and an estimate of the portfolio delta. Note that the trader has also the option to choose the combination of a +/-10% spot variation with a variation of +/-5 points of volatility. 14 VANILLA FX OTC OPTIONS WITH SAXO BANK

Margin Requirement To enable clients to efficiently manage their risk and capital Saxo Bank offers margin netting between Spot FX and OTC FX Option positions. If a client only holds bought FX Vanilla Options no margin is required since the premium is paid upfront and represents the maximum risk the client is exposed to. However, if a client chooses to trade in other FX margin instruments (FX spot and/or sold FX options) with at least one currency overlap, Saxo Bank s proprietary margining system kicks in. Saxo Bank applies a Delta Vega margin methodology on the entire portfolio in the given current cross. This would include an In- The-Money option being exercised into a spot trade at expiry. Square positions for Forex Options or FX spot are not taken into consideration. The margin requirements for Forex Vanilla Option positions at Saxo Bank consist of two components: Delta Margin is related to the changes in the underlying FX spot rate Vega Margin is related to the percentage change in volatility The calculation for the margin requirement of a Forex Vanilla Option position is therefore: MARGIN REQUIRED = DELTA MARGIN + VEGA MARGIN The calculation for the margin requirement of a Forex Vanilla Option position is therefore: MARGIN REQUIRED = DELTA MARGIN + VEGA MARGIN VANILLA FX OTC OPTIONS WITH SAXO BANK 15

Delta Margin The Delta of a Forex Option position describes how the value of the option (i.e. the premium) changes as a result of changes in the underlying Forex spot rate. The Delta of an FX Vanilla Option position multiplied by the notional amount gives the underlying spot exposure equivalent of the position at a specific point in time (i.e. DELTA EXPOSURE = NOTIONAL AMOUNT * DELTA). The calculation for the Delta Margin requirement of a Forex Option position is as follows: DELTA MARGIN = DELTA EXPOSURE * FOREX SPOT MARGIN RE- QUIREMENT When calculating the Delta Margin requirement for a new FX Vanilla Option position, all of the portfolio s current spot exposures both open FX spot positions and FX Vanilla Option spot exposures are considered. Vega Margin The Vega of an FX Vanilla Option position describes how the value of the Forex Option position changes as a result of changes in the implied volatility of the underlying Forex cross. The calculation for the Vega Margin component of a Forex Option position is given by the following formula: VEGA MARGIN = NOTIONAL AMOUNT * VEGA * MAX (IMPLIED VOLATILITY, FLOOR VALUE) * VOLATILITY FACTOR Volatility Factors are set per Currency Pair and Expiry Date tenor (see table below). Between these Expiry Date tenors the Volatility Factors are interpolated. The Volatility Factors for short dated Expiry Dates are higher than those for long dated Expiry Dates because the volatility of a long-term Forex Option position is relatively less dynamic than a short-term Forex Option position. When calculating the Vega Margin requirement for a Forex Option position, netting is performed across each Currency Pair for each Expiry Date. Thus, if a client has both bought and sold Forex Options in the same Currency Pair and for the same Expiry Date, the Vega Margin is calculated as the net of these positions. The Volatility Factors used in the Vega Margin calculation for major and minor currency pairs are shown below in tabular and graphical form. As noted above, Volatility Factors are interpolated between the expiry date tenors. Tenor Days Major Currency Pairs Minor Currency Pairs Short Positions Long Positions Shorts Positions Long Positions 1 week 7 28% -28% 50% -50% 2 weeks 14 20% -20% 25% -25% 1 month 30 11% -11% 20% -20% 3 months 90 8% -8% 15% -15% 1 year 365 8% -8% 10% -10% The next table shows the categorization of currencies for Major Currency Pairs. With respect to these Volatility Factors, a Major Currency Pair is one which includes BOTH of any of the currencies listed. Major Currencies AUD CAD CHF EUR CBP JPY NOK NZD SEK USD 16 VANILLA FX OTC OPTIONS WITH SAXO BANK

Exception for Bought Options If a client only holds bought FX Vanilla Options, then no margin is required to hold the FX Vanilla Option positions. However cash is required to pay the premiums for the bought FX Vanilla Options. If a client, in addition to bought Options, chooses to trade in margin instruments (spot and sold options) that would change the delta exposure in the existing portfolio. Hence the system uses the Delta Vega margin methodology on the entire portfolio in the given current cross. This would include an option being exercised into a spot trade at expiry. Square positions for Forex Options or FX spot are not taken into consideration. In summary no margin is required to hold long FX Vanilla Option positions if: Client holds no short option positions Client holds no FX spot in the same cross VANILLA FX OTC OPTIONS WITH SAXO BANK 17

Stop-out procedures Portfolio type Vanilla Options only Vanilla Options & Spot Margin handling / Stop out Stop-out is handled like any other margin instrument position. For bought Vanilla Options the client recieves bought option risk value (collateral on the back of the option). Vanilla options will be handled equally to any other margin instruments (no partioal stop-out) The system constantly monitors the risk of a short option position ending in-the-money (ITM) and long option position ending outthe-money (OTM). 18 VANILLA FX OTC OPTIONS WITH SAXO BANK

Product risk Danish banks are required to categorise investment products offered to retail clients depending on the product s complexity and risk as: green, yelleow or Red. Forex is categorised as a red product as it is considered an investment product with a high complexity and a high risk. See also the Product Risk Categorisation located under our General Business Terms. Disclaimer Unless specifically stated, no Publication of the Saxo Bank Group should be construed as an offer (or solicitation of an offer) to: buy or sell any currency, product or financial instrument, make any investment, or participate in any particular trading strategy(collectively Offers ). No representation, no warranty The Saxo Bank Group uses reasonable efforts to obtain information from reliable sources, but all Publications are provided on an as is basis without representation or warranty of any kind (neither express nor implied) and the Saxo Bank Group disclaims liability for any Publication not being complete, accurate, suitable and relevant for the recipient. Specifically, the Saxo Bank Group disclaims liability towards any subscriber, client, partner, supplier, counterparty and other recipients for: No Recommendations The Saxo Bank Group does not in any of its Publications take into account any particular recipient s investment objectives, special investment goals, financial situation, and specific needs and demands. Therefore, all Publications of the Saxo Bank Group are, unless otherwise specifically stated, intended for informational and/or marketing purposes only and should not be construed as: business, financial, investment, hedging, legal, regulatory, tax or accounting advice, a recommendation or trading idea, or any other type of encouragement to act, invest or divest in a particular manner(collectively Recommendations ). The Saxo Bank Group shall not be responsible for any loss arising from any investment based on a perceived Recommendation. Risk Warning Trading of products and services offered by the Saxo Bank Group, even when executed in accordance with a perceived recommendation, entails a risk and may result in both profits and losses. the accuracy of any market quotations, any delay, inaccuracy, error, interruption or omission in providing market quotations, and any discontinuance of market quotations. If a Publication becomes outdated the Saxo Bank Group shall be under no obligation to; update the Publication, inform the recipients of a Publication, or perform any other action. DISCLAIMER This material is produced for marketing and/or informational purposes only and Saxo Bank A/S and its owners, subsidiaries and affiliates whether acting directly or through branch offices make no representation or warranty, and assume no liability, for the accuracy or completeness of the information provided herein. Saxo Bank may change its offering and content of this catalogue without notice. The content of this catalogue shall not be relied up for any contractual purposes. This disclaimer is subject to Saxo Bank s Full Disclaimer available at www.institutional.saxobank.com/legal-documentation. VANILLA FX OTC OPTIONS WITH SAXO BANK 19