Ron,

Ultimately, currency options calculations depend on what you take as
numeraire- the domestic currency, and what you take as the foreign currency.
In the case of CME, EUR/GBP is quoted as pounds per euro, i.e. the domestic
currency is pounds and foreign currency is euro.

So if you were to price options on currencies using standard Merton's stock
formula, you use the risk free rate of UK as domestic, and risk free rate of
Euro zone as your "dividend yield".

To my knowledge, CME only has options on futures, not spot currency. And if
you are trying to price that, you basically plug in the risk free rate of UK
in the futures-options model, and you get the option premium in pounds. You
need to verify that CME option price is quoted it in pounds, I beleive it
does.

Mahesh



On Wed, May 6, 2009 at 1:12 AM, RON70 <ron_michael70@yahoo.com> wrote:

>
> In CME, option on forex is traded on EUR/GBP. If I want to price this
> option
> using some pricing formula then as Domestic risk free interest rate what
> should I take? Shouldn't risk free rate in UK be appropriate? I am asking
> this because as CME is in US, domestic currency is USD. Your suggestion
> appreciated.
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-- 
Mahesh Krishnan, Ph.D

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