Treating Foreign Interest as a Dividend Yield in FX Option Pricing

Summary

The document addresses how to interpret the dividend-yield input when adapting a vanilla option delta or pricing framework to foreign exchange. Its answer explains that an FX option’s underlying is an exchange rate and that holding the foreign currency has an economic role analogous to owning an asset that pays a yield. In this analogy, the foreign currency’s risk-free interest rate serves as the yield input.

This links familiar equity-option notation to FX conventions: the domestic and foreign rates both matter, with the foreign rate occupying the dividend-yield role in common pricing setups. The discussion is brief and gives no derivation, numerical example, delta convention, or treatment of market-specific quoting conventions. It therefore supplies a conceptual mapping, while implementation still depends on the precise pricing model and whether delta is spot- or forward-based.

Key ideas

• In FX option models, the foreign currency plays a role analogous to a dividend-paying asset.
• The foreign risk-free rate is used in the role of a dividend yield.
• The underlying for an FX option is the spot or forward exchange rate.
• The short explanation does not specify delta conventions or provide a numerical calculation.

Tags

# Delta formula for FX vanilla option


# Delta formula for FX vanilla option












What value do you use for annual dividend yield? It does not apply in case of FX.

## Answer by Mcav (score 1)

https://quant.stackexchange.com/a/15438

When pricing FX options, the underlying is the spot or forward exchange rate.

The foreign currency is analogous to a stock where the owner of the foreign currency receives a "dividend yield" equal to the risk-free rate in the foreign currency.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.