Integration

The following restrictions presently apply to the valuation of average spot options:

The system can currently only valuate average spot options with a European exercise type (European options).

The averages are only gathered at specific, predefined times that are equally distanced.

The system uses the arithmetic average with identical weightings to calculate the averages.

For more information on valuating the average spot options, see the Basket Options and Average Spot Options document in the Price Calculator documentation.

Procedure

Create the following hierarchy to display an average spot option as a generic transaction:

Create the hierarchy as follows:

Create a new generic transaction. See Edit Generic Transaction for the procedure.

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In the dialog structure, select the first elementary transaction and assign to it transaction form 061 (OTC option).

The system displays three tab pages.

Enter the following information on the Header Information tab page:

Start of term field.

Enter the start date for the term of the option.

End of term field.

Enter the end date for the term of the option.

Purchase/Sale field

Enter whether the OTC option is a purchase or a sale.

The system interprets the OTC option as a purchase or a sale depending on the entries you make for the elementary transaction on the highest level of the hierarchy.

Enter the following information on the Cash Flow tab page:

Cash Flow Type field

Specify the type of the cash flow (for example, sale or purchase cash flow).

Due Date field

Specify when the premium of the option is due.

CF Amount field

Currency field

Currency of the individual cash flows

Plus/Minus Sign field

Specify if the cash flow represents an in- or an outflow.

Enter the following information on the Option Information tab page:

Exercise Type field

Specify whether American-style or European-style exercise applies to the OTC option.

The price calculator is only able to valuate European-style exercise types.

Put/Call Indicator

Flag the OTC option as a put option or a call option.

Strike Amount and Strike Currency fields

Clean strike amount of option (price of underlying without accrued interest).

Number of Averaging Time Points field

Specify the number of planned fixing dates.

Number of Fixed Points field

Specify how many spots have already been fixed.

Next Averaging Date field

Specify when the next spot is to be fixed.

Mean Value of Exercise Price field

Specify the mean value of the spots that have already been fixed.

You must manually update the Number of Fixed Points, Next Averaging Date and Mean Value of Exercise Price fields. The system is unable to automatically correct or update the data.

You must enter a term start date for the option, although it is not used by the price calculator for evaluation purposes.

Create a transaction with the transaction form 41 (foreign exchange) under the OTC option elementary transaction for the first elementary transaction on the second level of the hierarchy. To do this, select the OTC Option elementary transaction in the dialog structure and choose Create Elementary Trans.: Next Level . Select the new elementary transaction and assign to it transaction form 41.

The system displays three tab pages. Specify two cash flows on the Cash Flow tab page that have different plus/minus signs. The ratio of the first cash flow to the second is equal to the strike rate.

Select Back and then Save

Result

You have created an average spot option with an elementary transaction of transaction form 61 (OTC option) on the first (highest) level of the hierarchy, and with a elementary transaction of the transaction form 41 (foreign exchange) on the lower, second level.

Example

A US company with a yearly revenue of 1.3 billion euro wants to protect itself from falling US dollar rates. The company buys an average rate put option at 1,3 billion euro that runs for a year and is due on 3.19.2005. In the month before the option is due, the euro/US dollar exchange rate is measured on every working day, and the readings are used to calculate the averages. The strike price for the option is the exchange rate at the time the option is concluded, 1.22 euro for each US dollar. The option premium is 460 million euro.

To valuate this option, create a corresponding generic transaction with the value Average Spot Transaction. To do this you need to make the following preparations and simplifications:

The strike price is shown in the system as a foreign exchange transaction with two cash flows in US dollars and euro. The euro-cash flow has an amount of 1.3 billion euro and represents an inflow (as a put-option was agreed). The US dollar cash flow amount is calculated using the strike rate.

The spot averaging is defined using the first averaging date and the number of grid points. Because the system only uses equidistant grid points, it can only enter the 2.19.2005 as the start date, and 20 as the number of grid points, without the days used necessarily being working days.

These simplifications usually only have, however, limited influence on the calculated NPVs of the option.