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NotesEUR C/USD Put, k=1.60Physical Deliveryhello to alli am new to FX so i was wondering if you could help me with the following:1.when pricing RKOs (i.e client buys 5year month EUR/USD Call, k=1.60, continuous up & out=1.62)2 different types of vol are relevant: a. the 5 year fwd vol (retrieved from the vanilla market) that drives the vol of the underlying call, and b.the spot vol (that drives the volatility of the spot) and hence the likely of KOHow do different banks price these?Do they explicitly publish spot vol, and hence calibrate to both Spot vol and forward vol?Do they use some other ad-hoc adjustment?2.How are American option exercise rules work in FX options, that are physically settled?i.e 5 year American option, EUR Call, k=1.60client has the right buy EUR @ 1.60 at any point in the next 5 years.But if there is delayed delivery (i.e to T-5 years) how would the exercise decision work?And how one would price it?In general it would be great if someone could shed some light into the issue of physical settlement.

Move to a 3-factor world (typically lognormal spot, possibly with a local vol skew correction, and 2 normal processes for the short rates). Calibrate to caps/swaptions and long dated fx vanillas. Then you need to make assumptions (based on historics) for the correlation matrix and then off we go....

the obvious problem with that of course is that refreshing your greeks on the fly is a midsummer night dream...i am aware of hybrid books that blew up b/c they had big short dated gamma positions and could not update their greeks until the next morning..