Forex Options Pricing Questions
Here are some frequently asked questions with regards to the different methods of pricing Forex Options.
Why do quotes differ between banks?
The price differences are a result of the difference of opinion with regards to the volatility of the option in question. The implied volatility is not a tradable asset class like the spot and it is often considerably less liquid. Depending on the liquidity and risk tolerance of the banks involved, some cover their positions back-to-back while others warehouse and are liquidity providers. In addition, the options market is not flat like the spot market (it contains gamma and vega) and as a result, a single quote in the options market can change the overall position in a way that cannot immediately be diversified. Furthermore, since some banks are committed to the position until expiration they occasionally use their prices to control their overall position.