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Algorithmic Trading and Prediction of Foreign Exchange Rates Based on the Option Expiration Effect
KTH, School of Engineering Sciences (SCI), Mathematics (Dept.), Mathematical Statistics.
2019 (English)Independent thesis Advanced level (degree of Master (Two Years)), 20 credits / 30 HE creditsStudent thesisAlternative title
Algoritmisk handel och prediktion av valutakurser baserade på effekten av FX-optioners förfall (Swedish)
Abstract [en]

The equity option expiration effect is a well observed phenomenon and is explained by delta hedge rebalancing and pinning risk, which makes the strike price of an option work as a magnet for the underlying price. The FX option expiration effect has not previously been explored to the same extent. In this paper the FX option expiration effect is investigated with the aim of finding out whether it provides valuable information for predicting FX rate movements. New models are created based on the concept of the option relevance coefficient that determines which options are at higher risk of being in the money or out of the money at a specified future time and thus have an attraction effect. An algorithmic trading strategy is created to evaluate these models. The new models based on the FX option expiration effect strongly outperform time series models used as benchmarks. The best results are obtained when the information about the FX option expiration effect is included as an exogenous variable in a GARCH-X model. However, despite promising and consistent results, more scientific research is required to be able to draw significant conclusions.

Abstract [sv]

Effekten av aktieoptioners förfall är ett välobserverat fenomen, som kan förklaras av delta hedge-ombalansering och pinning-risk. Som följd av dessa fungerar lösenpriset för en option som en magnet för det underliggande priset. Effekten av FX-optioners förfall har tidigare inte utforskats i samma utsträckning. I denna rapport undersöks effekten av FX-optioners förfall med målet att ta reda på om den kan ge information som kan användas till prediktioner av FX-kursen. Nya modeller skapas baserat på konceptet optionsrelevanskoefficient som bestämmer huruvida optioner har en större sannolikhet att vara "in the money" eller "out of the money" vid en specificerad framtida tidpunkt och därmed har en attraktionseffekt. En algoritmisk tradingstrategi skapas för att evaluera dessa modeller. De nya modellerna baserade på effekten av FX-optioners förfall överpresterar klart jämfört med de tidsseriemodeller som användes som riktmärken. De bästa resultaten uppnåddes när informationen om effekten av FX-optioners förfall inkluderas som en exogen variabel i en GARCH-X modell. Dock, trots lovande och konsekventa resultat, behövs mer vetenskaplig forskning för att kunna dra signifikanta slutsatser.

Place, publisher, year, edition, pages
2019.
Series
TRITA-SCI-GRU ; 2019:068
Keywords [en]
Option expiration effect, option relevance coefficient, algorithmic trading, time series analysis, GARCH-X.
Keywords [sv]
Effekten av optioners förfall, optionsrelevanskoefficient, algoritmisk handel, tidsserieanalys, GARCH-X.
National Category
Probability Theory and Statistics
Identifiers
URN: urn:nbn:se:kth:diva-252297OAI: oai:DiVA.org:kth-252297DiVA, id: diva2:1319888
External cooperation
Swedbank Markets
Subject / course
Financial Mathematics
Educational program
Master of Science - Applied and Computational Mathematics
Supervisors
Examiners
Available from: 2019-06-04 Created: 2019-06-03 Last updated: 2019-06-04Bibliographically approved

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CiteExportLink to record
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