First in your OP, you talk about drift-adjustment while you simply describe the variance. Well yes, this comes from the interpretation of an option price as the initial endowment of a perfect replicating portfolio. At inception, the quanto contract fixes the exchange rate between the two currencies. Sign up using Facebook. It can be shown that this quanto is not tradable in the US dollar market. Is this an appropriate way to approach this?
What is a 'Quantity-Adjusting Option - Quanto Option' A quantity-adjusting option, also known as a quanto option, is a cash-settled, cross-currency derivative, where the underlying asset is denominated in a currency other than the currency in which the option is settled. Another name for these options is a guaranteed exchange rate option.
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Example 2: Quanto call option on a stock. Consider a call option on a British stock. The option has a payoff in US dollars with a fixed FX rate of 5 dollars per one pound. Suppose the stock has a spot price of (£), the strike price is 90 (£). Today’s date is Aug. 1, The expiration date of the option is Feb. 1, Quanto options have both the strike price and underlier denominated in the foreign currency. At exercise, the value of the option is calculated as the option's intrinsic value in the foreign currency, which is then converted to the domestic currency at . Quanto Options 3 EUR USD XAU V 2 V 3 V 1 M 12 M 12 S M 23 S M 23 Figure 1: XAU-USD-EUR FX Quanto Triangle. The arrows point in .