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.1.3.1 ExerciseThe exercise normally has to be announced by the option s buyer at 10:00 AM New Yorktime; options are denominated NY Cut in this case, and they are the standard options traded inthe interbank market.The counterparties may also agree on a different time; such as 3:00 PMTokyo time; in this case we have the Tokyo Cut.The exercise is considered automatic for a givenpercentage of in-the-moneyness of the options at expiry (e.g., 1.5%), according to the ISDAmaster agreement signed between two professional counterparties before starting any tradingactivity between them.In other cases the exercise has to be announced explicitly, although itis market fairness to consider exercised (or abandoned) options manifestly in-the-money (orout-of-the money), even without any call from the option s buyer.1.3.2 Expiry date and settlement dateThe expiry date for an option can be any date when at least one marketplace is open, then thesettlement date is set according to the settlement rules used for spot contacts.Some markettechnicalities concern the determination of the expiry and settlement (delivery) dates for whatwe call canonic or standard dates.In more detail, in the interbank market daily quotes areeasily available for standard expiries expressed in terms of time units from the trade date, i.e.,overnight, weeks, months and years.Day periods.Overnight is the simplest case to analyse, since it indicates an expiry for thenext available business day, so:1.In normal conditions it is the day after the trade date or after three days in case the tradedate is a Friday (due to the weekend). 12 FX Options and Smile Risk2.The expiry is shifted forward if the day after the trade date is not a business day all aroundthe world (e.g., 25 December).On the contrary if at least one marketplace is open, then theexpiry date is a good one.3.Once the expiry date is determined, the settlement date is calculated with the rules appliedfor the spot contract.If the standard expiry is in terms of number of days (e.g., three days), the same procedureas for overnight applies, with expiry date initially and tentatively set as the number of daysspecified after the trade date.Week periods.This case is not very different from the day period one:1.The expiry is set on the same week day (e.g., Tuesday) as the trade date, for the givennumber of weeks ahead in the future (e.g., 2 for two weeks).2.At least one marketplace must be open, otherwise the expiry is shifted forward by one dayand the open market condition checked again.3.Once the expiry is determined, the usual rules for the spot contract settlement date apply.Month and year periods.In these cases a slightly different rule applies, since the spotsettlement date corresponding to the trade date is the driver.More specifically:1.One moves ahead in the future by the given number of periods (e.g., 6 for six months), thenthe same day of the month as the spot settlement date (corresponding to the trade date, inthe current month) is taken as the settlement date of the option (e.g., again for six-monthexpiry, if the trade date is the 13th of the current month and the 15th is the settlement datefor a corresponding spot contract, then the 15th day of the sixth month in the future will bethe option settlement date).If the settlement date of the future month is not a valid date forthe pair involved, then the date is shifted forward until a good date is achieved.2.If the settlement determined in (1) happens to fall in the month after the one correspondingto the number of periods considered (e.g., the six-month expiry yields a settlement actuallyfalling in the seventh month ahead), then the end-of-month rule applies.From the firstsettlement date (identified from the spot settlement of the trade date), the date is shiftedbackward until a valid (for the contract s pair) settlement date is reached.3.The expiry can now be calculated by applying backward from the settlement date the rulesfor a spot contract.4.The year period is treated with same rules simply by considering the fact that one yearequals 12 months.We provide an example to clarify the rules listed above.Example 1.3.1.Assume we trade an option EUR call USD put with expiry in one month.Weconsider the following cases:" The trade date is 19 October 2007.From the market calendars the spot settlement datefor such a trade date can be calculated and set on 23 October so that the settlement ofthe option has to be set on 23 November (i.e., the same day one month ahead).This datecan be a settlement date for the EURUSD pair and the corresponding expiry date is 21November, since the 22nd is a holiday in the USA but is counted as a business day accordingto the spot date rules.Actually, we know from Example 1.1.2 that the spot trades dealt on20 November also imply a settlement date on the 22nd [ Pobierz całość w formacie PDF ]