Wednesday, August 26, 2015

Giles Jewitt’s FX Derivatives Trader School (Wiley, 2015) is a first-rate book, intended for serious, numerate readers. (And by ‘numerate’ I don’t mean math Ph.D.s, only those who don’t cringe at the sight of a few formulas.) It collects and expands upon monthly “Trader School” e-mails he sent to traders on the FX derivatives trading desk at HSBC, where he is currently employed as head of FX Options Automated Trading and eRisk. It covers everything from the basics, the volatility surface, and vanilla derivatives through exotic FX derivatives trading. Although it was written for junior FX derivatives traders and traders trying to expand or refresh their knowledge, it is also worthwhile reading for anyone who trades either currencies or options on underlyings other than currencies.

Jewitt has a knack for clarifying concepts that traders often rely on but don’t really understand. Take, for instance, the notion of a Wiener process (also called Brownian motion). “A Wiener process is a continuous stochastic process with stationary independent increments. Translating:

• ‘Continuous’ means ‘its path doesn’t jump.’
• ‘Stochastic’ means ‘it moves.’
• ‘Stationary’ means ‘its probability distribution does not change over  time.’
• ‘Independent increments’ means ‘each change does not depend on  any previous changes.’” (p. 61)

For those who can handle VBA, Jewitt includes a series of so-called practicals. He implores students and new traders not to cheat and download the spreadsheets available to those who buy the book unless they get completely stuck. The seven practicals encompass building a trading simulator, a numerical integration option pricer, and a Black-Scholes option pricer, generating tenor dates, constructing an ATM curve and a volatility smile, and generating a probability density function from option prices, all in Excel. (Dare I admit that I cheated?)

The chapter on vanilla FX derivatives risk management is especially illuminating, describing how good traders manage their positions. I was also intrigued by the discussion of ATM volatility and FX correlation, especially the ATM volatility triangles.

All in all, Jewitt’s book will probably take most readers’ knowledge of options trading (and certainly of FX options trading) up two or three notches. It’s worth investing the mental effort to work through the text.