DRAFT
Diagrams drawn using EDWG-2002-12-27
In FpML version 3.0 the equityOption component was defined to describe "vanilla" options with the following characteristics:
For FpML 4.0 this component has been extended to encompass more exotic types of options, including:
Many of the above can be combined through the use of a single component architecture that has a number of optional features. Compound options (such as Butterfly and Straddle structures) can be represented by combining two or more equityOption components in a strategy component. In this way the vast majority of equity option structures that are used between wholesale market counterparties can be represented in FpML.
The product architecture draws heavily on ISDA's 1996 definitions for equity derivatives as updated by the emerging 2002 definitions. Wherever possible the terminology and practice of the ISDA definitions has been adopted to ensure consistency between traditional and FpML contract representations.
In the equityOption component buyerPartyReference and party components that specify the option buyer and seller respectively. The type of the option (call or put) is specified in optionType. The effective date for a forward starting option is specified in equityEffectiveDate
The underlyer of an equity option may be either a single underlyer, or basket, specified using the underlyer component specified below
The strike is expressed either as a price (strikePrice) or as a percentage (strikePercentage) of the forward starting spot price. An optional currency element caters for the case where the strike price is expressed as a monetary amount, rather than as a level.
The numberOfOptions element specifies the number of options in the option transaction. The optionEntitlement element specifies the number of shares per option. The number of options, strike price and notional are linked by the equation:
notional amount = number of options x
option entitlement x strike price
Provided that two of notional amount, number of options and option entitlement are specified, then the third may be omitted.
spotPrice is the price per share, index or basket observed on the trade or effective date. It is only used for forward starting options.
The exercise provisions for the option are specified in the equityExercise component. American, European and (new in FpML 4.0) Bermudan styles are all catered for. The equityExercise component is described in more detail below.
Quanto options are handled using the new FXFeature component, which is described below.
Where necessary many other non-vanilla features are specified in the optional equityOptionFeatures component, which is also new in FpML 4.0. This component is described in more detail below.
The equityPremium component specifies the amount and timing of the premium payment that is made for the equity option. It is described in more detail below.
Where the underlying is shares, the extraordinaryEvents component specifies marketevents affecting the issuer of those shares that may require the terms of the transaction to be adjusted. The methodOfAdjustment component specifies how adjustments will be made to the contract should one or more of the extraordinary events occur.
The underlyer component specifies the asset(s) on which the option is granted, which can be either on either a singleUnderlyer or basket, and consist of equity, index, or convertible bond components, or some combination of these
The description element is used to provide a free-form
text description of the asset, whereas instrumentId contains a short-form, unique
identifier (e.g. ISIN, CUSIP) for the asset. At least one instrumentId
must be present.
The exchangeId element contains a short form unique identifier for an exchange. If omitted then the exchange shall be the primary exchange on which the underlying is listed. The relatedExchangeId element contains a short form unique identifier for a related exchange. If omitted then the exchange shall be the primary exchange on which listed futures and options on the underlying are listed.
The clearanceSystem element contains the identity of the clearance system to be used. If omitted, the principal clearance system customarily used for settling trades in the relevant underlying shall be assumed.
FpML 4.0 supports three styles of equity option: European, American and Bermudan. For consistency of representation with interest rate derivatives each of these styles is represented using its own component. Each of these components is described more fully below. The automaticExerciseApplicable element contains a boolean value to indicate whether or not the option (or any remaining portion of the option, if multiple exercise is permitted) is exercised automatically if it expires in the money.
The equityValuation component specifies the date and time on which the option is valued. The element valuationTimeType enables the valuation time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element valuationTime is used to specify an explicit time of day.
The futuresPriceValuationApplicable element contains a boolean value to indicate whether or not the official settlement price as announced by the related exchange is applicable, in accordance with the ISDA 2002 definitions.
The settlementDate
component specifies when the option is to be settled relative to the
valuation date. If the settlement date is not specified explicitly then
settlement will take place on the valuation date. The settlementType component is used to specify whether
the option is settled in cash or physically.
The settlementPriceSource element specifes the source from which the settlement price is to be obtained, e.g. a Reuters page, Prezzo di Riferimento, etc.
The failureToDeliverApplicable element is used where the underlying is shares and the transaction is to be physically settled. The element contains a boolean value that, if "true", then a failure to deliver the shares on the settlement date shall not be an event of default for the purposes of the master agreement.
The sub-components of the equityEuropeanExercise component specify the date and time when the option will expire. The element equityExpirationTimeType enables the expiration time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element equityExerciseTime is used to specify an explicit time of day.
The commencementDateexpirationDate are used to specify the period during which the option may be exercised (more than once if permitted by the equityMultipleExercise component). The option may be exercised on any business day in this period up to the latest time specified for exercise. The element equityExpirationTimeType enables the expiration time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element equityExerciseTime is used to specify an explicit time of day.
The element latestExerciseTimeType enables the latest exercise time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element latestExerciseTime is used to specify an explicit time of day.
The commencementDateexpirationDate components are used to specify the period during which the option may be exercised (more than once if permitted by the equityMultipleExercise component). The option may be exercised on any of the days in the list bermudanExerciseDates up to the latest time specified for exercise. The element equityExpirationTimeType enables the expiration time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element equityExerciseTime is used to specify an explicit time of day.
The element latestExerciseTimeType enables the latest exercise time to be expressed as relative to some other event, such as the close of business for the exchange. Alternatively if its value is "Specific" then the element latestExerciseTime is used to specify an explicit time of day.
The type of FX feature is specified in the element FXFeatureType, and may be either Quanto or Composite
The FX rate may be specified as an explicit rate using FXRate, or by using the FXSource component to specify the source from which the FX rate is to be obtained.
Three types of option features are catered for in FpML 4.0: asians, barriers and knocks. All of these are path-dependent options. Asian features are described below. Barriers may be caps or floors; knocks may be knock-ins or knock-outs - these share a common architecture that is described below.
A binary option (also known as a digital option) is a special case of a barrier where the payout is specified to be a fixed amount rather than a percentage of the value of the underlying on the date that the option is triggered.
An asian option is one in which an average price is used to derive the strike price ("averaging in") or the expiration price ("averaging out") or both. The type of averaging is specified in the averagingInOut element.
The period over which the averaging is calculated is specified in the component averagingPeriodIn or averagingPeriodOut as appropriate. Both components have the same structure. The period is specified either as a calculation, using one or more schedule components (which permits specifications such as every Friday from and including 24 May 2002 to and including 22 November 2002), and/or as a list of explicit dates and times, using the averagingDateTimes component. It is permissible to use the list of dates and times to specify averaging points that are additional to those derived from the calculation rule specified in schedule components. In the event that any of the dates is not a business day then it is assumed that it will be rolled forward to the next business day in accordance with ISDA convention.
The marketDisruption element specifies the action to be taken if it is not possible to obtain a price on one of the days used for averaging.
A barrier option is one in which, if the option expires in the money, an additional payment will occur. With a barrier cap the additional payment will be made if the trigger level is approached from below, whereas with a barrier floor the additional payment will be made if the trigger level is approached from above.
Knock options are of two types. A knock-in option does not come into effect until the trigger level has been reached, if it is never reached then the option expires worthless. Conversely, a knock-out option expires immediately the trigger level is reached.
A common structure is used to specify barrier caps, barrier floor, knock-ins and knock-outs. The diagram shows the barrierCap structure.
The dates on which the underlying is valued to test for the occurrence of the trigger event are either expressed in one or more schedule components and/or as a list of explicit dates, using the triggerDates component. It is permissible to use the list of dates to specify trigger dates that are additional to those derived from the calculation rule specified in schedule components. In the event that any of the dates is not a business day then it is assumed that it will be rolled forward to the next business day in accordance with ISDA convention.
The trigger component specifies that the trigger event either as a level or as a levelPercentage (of the strike).
The optional featurePayment component specifies a payment to be made if the trigger event occurs. The payment date can be expressed either as an explicit date or as relative to some other date, such as the trigger date or the contractual expiry date.
The equityPremium component specifies the amount and timing of the premium payment that is made for the equity option. payerPartyReference and receiverPartyReference are pointer style references to party components that specify the payer and receiver of the premium respectively.
In FpML 4.0 the premium amount can be expressed in a number of ways: as a monetary amount (paymentAmount), as a price per option or as a percentage of the notional - if more than one method is used then they must be mutually consistent. There are circumstances in which no premium would be specified, for example if the trade formed part of a put/call combo structure.
The swapPremium element holds a boolean value that, if "true" specifies that the premium is to be paid in the style of payments under an interest rate swap contract.
When a date specified in an equity option contract falls on a non-business day then it may be necessary to adjust it to be a business day. At the time the contract is agreed it is not always possible to determine whether or not a particular date in the future will be a business day.
The meaning of "business day" varies according to the context in which it is used. When the context is the payments of monetary amounts then the rules for adjustment according to currency business days apply, and the equity option product architecture uses the same AdjustableOrRelativeDate component ( or derivations ) as the interest rate and foreign exchange products.
However, when the context is the valuation or settlement of equities or equity indices then the term "business day" means "exchange business day". In this case the equity option product architecture specifies the use of unadjusted dates with the adjustment rules being implicitly inherited from the ISDA definitions.
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