Jewitt - FX Derivatives Trader School

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Copyright 2015 by Giles Jewitt. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

ISBN 9781118967454 (Paperback)

ISBN 9781119096610 (ePDF)

ISBN 9781119096474 (ePub)

Cover image: Business World iStock.com/ktsimage; abstract background iStock.com/PiexelEmbargo

Cover design: Wiley

For my wife and daughters: Laura, Rosie, and Emily.

In 2004 I started on an FX derivatives trading desk as a graduate. I wrote down everything I learned: how markets worked, how FX derivatives contracts were risk-managed, how to quote prices, how Greek exposures evolve over time, how different pricing models work, and so on. This book is a summary of that knowledge, filtered through a decade of trading experience across the full range of FX derivatives products.

In 2011 I started sending out monthly Trader School e-mails to traders on the desk, covering a wide range of topics. The e-mails were particularly popular with new joiners and support functions because they gave an accessible view of derivatives trading that did not exist elsewhere. This book collects together and expands upon those e-mails.

Part I covers the basics of FX derivatives trading. This is material I wish I'd had access to when originally applying for jobs on derivatives trading desks. covers exotic FX derivatives trading, starting with the most basic products and slowly increasing the complexity up to advanced volatility and multi-asset products. This material will mostly be useful to junior traders or traders looking to build or refresh their knowledge in a particular area.

Fundamentally, the aim of the book is to explain derivatives trading from first principles in order to develop intuition about derivative risk rather than attempting to be state of the art. Within the text, experienced quant traders will find many statements that are not entirely true, but are true the vast majority of the time. Endlessly caveating each statement would make the text interminable.

Traders can only be successful if they have a good understanding of the framework in which they operate. Importantly though, for derivatives traders this is not the same as fully understanding derivative mathematics. Therefore the mathematics is kept to an accessible advanced high school level throughout. Some mathematical rigor is lost as a result of this, but for traders that is a price worth paying.

Also in the interests of clarity, some other important considerations are largely ignored within the analysis, most notably, credit risk (i.e., the risk of a counterparty defaulting on money owed) and interest rates (i.e., how interest rate markets work in practice). Derivative product analysis is the primary concern here and this is cleaner if those issues are ignored or simplified.

Regulations and technology are causing significant changes within the FX derivatives market structure. The most important changes are increasing electronic execution, increasing electronic market data, more visibility on transactions occurring in the market, and less clear distinctions between banks and their clients. These changes will have profound and lasting effects on the market. However, the ideas and techniques explored within the book hold true no matter how the market structure changes.

Finally, and most importantly, if you are a student or new joiner on a derivatives trading desk: Do the practicals. I can guarantee that if you complete the practicals, you will hit the ground running when you join a derivatives trading desk. Do them. Do them all. Do them all in order. Do not download the spreadsheets from the companion website unless you are completely stuck. When you're trying to learn something, taking the easy option is never the right thing to do. The practicals require the ability to set up Excel VBA (Visual Basic for Applications) functions and subroutines. If you aren't familiar with this, there is plenty of material online that covers this in detail.

The very best of luck with your studies and careers,

Giles Jewitt, London, 2015.

Thanks are due to

those who taught me:

1. Fred Boillereau
2. Jeff Wang
3. Mike Killen
4. Rob Ross
5. Hossein Zaimi

those who supported me in writing the book and helped make it happen:

1. Howard Savery
2. Caroline Prior
3. Vincent Craignou
4. Selene Chong

all colleagues who helped me with content, especially:

1. Chris Potter
2. Charlie Chamberlain