The gap between the theoretical
(mark-to-model) and the real market value of FX options
has always been a thorn in the side of the fast-growing
derivatives market. That gap is particularly wide when
it comes to exotic structures (and employee stock
options, see below).
Both banks and corporate hedgers
have been concerned about the pricing of FX options,
often for different reasons. Banks want to make sure
they can lay off their risk cost effectively.
Corporates, meanwhile, want to make sure banks do not
overcharge.
A confluence of
trends
Several recent trends have brought
this gap (between what models say the option should be
worth and the price that the market is actually willing
to pay for it) into sharper focus.
• Regulatory issues. FAS 133
and IAS 39 have made the fair value of an option of
significant concern to corporates; that’s because the
derivatives’ accounting rules mandate that companies
carry options and other derivatives at fair value on
their balance sheet. Just what’s fair, hence, has
suddenly become very important not only when
purchasing/trading an option, but on an ongoing
basis.
Corporate hedgers need to price
their option hedges quarterly, and that quarterly
“price” is critical to the measurement of the hedges’
effectiveness, and hence what gets recognized in the
income statement and where.
In the past, banks have often
supplied their corporate customers with pricing for
“free.” But in the post FAS-133 era, simply relying on
the bank became less workable because of (1) the
frequency of the measurement; and (2) the need for
objectivity in the value assessment.
• Market dynamics.
Meanwhile, past large derivatives debacles (e.g.,
P&G) have convinced corporate hedgers of a basic
axiom: “If you cannot price it, don’t use it.” This,
plus pressure to cut costs have pressured many to seek
alternative (and objective, i.e., not provided by the
bank that’s selling the structure) pricing
models.
A real vs. M-T-M
price
Against this backdrop, independent
providers of analytics have stepped in to help corporate
treasurers price their derivatives. Unfortunately, some
(with a banking background) have failed to adjust to
corporate realities, costs and issues. One company,
however, which did originally cater to banks, is making
an interesting transition.
SuperDerivatives is a
website-resident pricing model, which made its mark by
being able to produce the real market price of exotic
options, vs., the typical Black Scholes-based pricing.
The company began its life selling the model to banks,
as either a primary or secondary model. More recently,
it has simplified its user interface so that it’s just
as easy and quick to price plain-vanilla options and
turned its attention to corporates.
“The intention was always to sell
SuperDerivatives to the whole of the options spectrum,”
notes Lee Oliver, a company spokesman.
According to one corporate FX
manager who’s company will soon start pricing options on
the site (http://www.superderivatives.com/),
the goal is to check on bank pricing, without having to
competitively bid every deal. This will not only save
time and money, but is also better from a bank credit
relationship standpoint.
What about ESOs? No where is
the gap between “real” and mark-to-model price wider
than in the pricing of employee stock options (see
TRAS, 3/24/03).
David Gershon, CEO of SuperDerivatives, says he is ready
to apply the solution to ESOs, ideally offering the same
transparency to that market as he has done with
FX.