Forex options trading make use of various ways to effect the valuation of currency options. The two most popular models employed in determining the option values are the Black Scholes model and the stochastic volatility model. The former was brought about by Fischer Black and Myron Scholes, thus the name of the model. The two came up with a solution for the theoretical price of options in Europe in 1970. Though this model posed some problems in application, it nevertheless was one of the most vital methods in option valuation that served as foundation for other models.
The Stochastic volatility models, including the Heston model, are formed basically due to the volatility of the time and the price of the underlying spot. It may be solved in closed-form or via a more complex numerical methodology.
When the valuation model has been chosen from the two types mentioned, more models and techniques may be used to implement them. The analytic technique is the first one that can be used. It is a mathematical model that produces closed-form solutions. These solutions are quite useful because they can be calculated fast.
Another model for valuation implementation is the binomial tree pricing model. This involves the dynamics of the theoretical value of the forex options for a discrete time interval over the duration of the option. This model is more widely used by option traders.
Another model that negates the use of mathematical calculations and solutions, are the Monte Carlo models. These models determine the option's value through a set of economic scenarios which yields an expected value for the options.
There are more models used to give value to the currency options. The finite difference models and other such similar methods may be employed depending on trader's choice.
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