5.1.2 Currency Options
This topic describes the auto exercise, settlement, knock in and knock out, auto settlement, and auto expiry process for currency options.
a. Auto Exercise
Currency options with American and Bermudan Expiration styles are eligible for auto exercise only if they are in-the-money on the day of maturity. An option with Bermudan schedule is Chapter 5 Automatic Events Executed during End of Day 5-7 exercised automatically on maturity only if it is in-the-money and the maturity date is included as a possible Exercise Date.
b. Settlement
For Currency options, settlement is done on the exercise settlement date which will be derived based on the exercise payment at hit or maturity, payment lag days and holiday preferences. A rebate can be paid only at maturity for an option which is not knocked in.
In this case, a queue is populated at the time of knocking out of the option (just like as in IROs) and actual settlement happens with the counter party on the maturity date or beyond maturity date. For European style currency options, only auto exercise is possible so the exercise (EXER) will trigger on the maturity date if the option is in the money whereas the settlement (EXST) will be derived based on the payment lag days and holiday preferences.
If EXER and EXST are not fired on the same date, then the contract status will be exercise initiated once the EXER is triggered. The contract status will be updated as exercised once EXST is triggered.
Auto exercise batch runs during BOD as well as EOD. For Currency options, spot rate can change on the date of maturity itself and they can become in the money.
For a detailed list of Amount tags and accounting entries to be passed during exercise process, refer to Annexure B.
c. Knock In and Knock Out (Event KNIN and KNOT)
The Knock-in and Knock-out events are applicable only for Currency Options. During this event the system identifies all active and authorized currency option contracts, and the processing date is between the Barrier Window Start date and Barrier Window End date as specified in the Contract Online screen.
The Spot rates for the current processing date is matched against the barrier and the lower barrier (If any), and the contract status is updated to Knocked In or Knocked Out, as may be the below case.
- Up and in Knock in (UIKI): If spot rate is greater than barrier price, then Knock in will be triggered
- Down and in Knock in (DIKI): If spot rate is lower than barrier price, then Knock in will be triggered
- Up and Out Knock Out (UOKO): If spot rate is greater than barrier price, then Knock out will be triggered
- Down and Out Knock Out (DOKO): If spot rate is lower than barrier price, then Knock out will be triggered
If Digital and No touch options are selected as the option style, the processing is simillar to Binary.
In case of a Knock Out event, a rebate can be paid/received to/from the counter party depending on whether the options contract is purchased or written respectively. Rebate can be paid when the option gets knocked out (Hit) or during maturity. If the rebate is to be paid at the time of Hit, the system triggers the Knock Out Settlement (KNST) event along with KNOT and the settlement is performed. If the rebate is to be paid at maturity, the auto settlement batch process processes the settlement with the counter party at maturity.
In case a rebate is applicable in the case of an option not being knocked-in during the barrier window, the settlement is processed at the time of expiry (maturity) of the contract. In this case the Knock In Settlement (KIST) is triggered along with Expiry of contract (EXPR) at the time of expiry (maturity).
In case of an option not being knocked-in during the barrier window, rebate settlement as a part of KIST event and EXPR event is triggered on the maturity date of the contract. Considering payment lag days and holiday preferences, rebate settlement can be beyond the maturity date in such a case contract gets expired after KIST is triggered.
This process is executed only during the EOD run.
d. Auto Settlement (KNST, KIST, PRPT)
As it is seen above, in many cases settlement is deferred until contract maturity (schedule maturity in IROs). In such cases during Auto Settlement the system processes the settlement with the counter party. This process is executed both during BOD and EOD and processes settlement for the following events:
- Rate Reset happening on a separate date from the schedule maturity date in case of an Interest Rate option (Except Swaption). In this case the event EXER is triggered along with RTFX (Rate fixing) but settlement happens at maturity of the schedule.
- A currency option being knocked out (KNOT) with rebate payment on maturity. The KNST event is triggered based on the payment lag days and holiday preferences. In this case the EXPR event is not triggered.
- A currency option with a knock in barrier not being knocked in during the barrier window with rebate to be paid on maturity. In this case KIST (Knock in Settlement) is triggered based on the payment lag days and holiday preferences. The status of the contract will be changed as Expire (EXER) after the knock in settlement is triggered.
- Premium payment (Event PRPT) happening on a date other than the contract booking date.
This event reverses the entries passed by the events above and process the settlement with the customer.
e. Auto Expiry (EXPR)
This process is executed during EOD as well as BOD and expires the options contracts, which are out-of-the-money on their maturity dates. BOD runs only till one working day before the Current Date. In the case of a Swaption, the option expires on maturity date if it is has not been exercised (An Interest Rate Swap is not entered into in case of a physical swaption).
As seen above, in some cases the event KIST can be triggered along with the EXPR event when the payment lag day is zero.
Before Auto Expiry event is triggered, revaluation at zero is done for the contract. This means that since the contract has expired worthless (It has not been exercised during its tenor), the loss borne by the buyer of the contract is equal to the option premium paid. In case of a written contract this would signify a profit for the writer.
Amortization of Deferred inception gain (AMRT) in case of trade deals and amortization of Deferred termination gains (AMDG) and Time Value (REVL) in case of hedge deals is also triggered before expiry of a contract. In case of event AMDG being triggered, expiry event EXPR is not triggered since the option has already being terminated and only the deferred termination gains are being amortized.
All the revaluation gains/losses and inception gains are posted to Income or Expense GLs.
For examples, refer to Example 11 and Example 12 in the section Examples of Different Types of Exotic Currency Options in Annexure B.
Parent topic: Automatic Events Executed during End of Day