In this example, we demonstrate the pricing of a plain vanilla European Call option on foreign exchange. Our aim here is to calculate the premium of this financial derivative.
The full details of the contract, including the choice of mathematical model and its numerical method, are shown in the following Bento Box template for European Call FX option (FX1).
We proceed by completing the contents of the Bento Box in clockwise sense, starting from the top-left corner. The following are the steps to do so:
Derivative contract: We first fill all the data of the contract, in particular the payoff function, which in our case is as follows:
Math model: We ought to select the mathematical model for the underlying, which in the case of currencies is the Garman-Kohlhagen model.
Numerical method: We select the numerical method to be used and in this case, we choose the finite difference method.
Algorithm...