Option replication and exotics journal

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Another basic question here coupled with an observation first...and many thanks again for being willing to explain your thinking to a real novice.

In some sense, I am starting to think about the basic 1 week no-touch position as the equivalent of the OTM puts that are being discussed on the SPX thread on this site. It's noteworthy though that your payouts are typically 100% on your basic one sided position compared with the single digit return on the monthly OTM spreads.

So, my question is as follows:

Are the higher payouts a function of barrier option one touch condition in particular? Or is it primarily related to the risk of the position? Coming at it another way what is the difference in the premiums for a 1 week SPX option and a 1 week barrier option at the same strike?

Probably I should just be going back in the thread and ordering some of the books you recommended at the beginning. But I have to admit that a dialogue with a practitioner leads me to a better understanding than a dry text. :)

Thanks again,

Sam
 
Quote from riskarb:

DAX double no touch -- 4900//5075
Premium: $49,600
Payout: $240,000 [includes prem paid]
Expires: Nov 10, 2005

Narrow range double -- fully expect to get hit, but well priced for a lottery ticket.
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I calculate the no touch odds to be at 31% ( hence , the payout = 209600 including the premium paid). I don't understand how they took/offered the 240k payout (26% chance of no touch). Obviously my calcs are incorrect (cannot find why) . Riskarb , do you have a tool to calculate those odds?
Thanks
 
Quote from IV_Trader:

I calculate the no touch odds to be at 31% ( hence , the payout = 209600 including the premium paid). I don't understand how they took/offered the 240k payout (26% chance of no touch). Obviously my calcs are incorrect (cannot find why) . Riskarb , do you have a tool to calculate those odds?
Thanks
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What vol-line and spot price were you using? Did you use atm implied vols? I did find the pricing better than I'd modeled, but not to the tune of $30,000 under quoted -payout. I didn't save the excel sheet, but I remember valuing the position at $55-$56k. At the time I assumed there was some econ or macro issues coming that week in Germany.

I use MBRM's exotics add-in most often.
 
Quote from ssternlight:

Another basic question here coupled with an observation first...and many thanks again for being willing to explain your thinking to a real novice.

In some sense, I am starting to think about the basic 1 week no-touch position as the equivalent of the OTM puts that are being discussed on the SPX thread on this site. It's noteworthy though that your payouts are typically 100% on your basic one sided position compared with the single digit return on the monthly OTM spreads.

So, my question is as follows:

Are the higher payouts a function of barrier option one touch condition in particular? Or is it primarily related to the risk of the position? Coming at it another way what is the difference in the premiums for a 1 week SPX option and a 1 week barrier option at the same strike?

Probably I should just be going back in the thread and ordering some of the books you recommended at the beginning. But I have to admit that a dialogue with a practitioner leads me to a better understanding than a dry text. :)

Thanks again,

Sam
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It's a function of the forward gamma distro and risk, and null payout if the barrier is struck. Basically it's a matter of pricing an equivalent strike vanilla, but with far > gamma sensitivity. The barrier condition is obviously significant to pricing and shouldn't be underestimated. As vanillas are priced in vol, exotics are priced in g/d. A vanilla option has the added cushion of the premium credit beyond the strike -- implying an increase in the distro. Sigmas = $value, but not in statistical likelyhood.

The only text I've read that touched on exotics was Taleb's book.
 
Quote from Trend Fader:

Riskarb.. thanks for this thread.. this is by far the best one in ET's history... i have never read a more informative thread..

I will be printing out each page.. tons to learn from your expert exotic options trading...


thanks man..


--MIKE
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Thanks for the encouragement. I'm glad this thread has been a value-add to some.
 
Quote from riskarb:

What vol-line and spot price were you using? I did find the pricing better than I'd modeled, but not to the tune of $30,000 under ThVal. I didn't save the excel sheet, but I remember valuing the position at $55-$56k. At the time I assumed there was some econ or macro issues coming that week in Germany.

I use MBRM's exotics add-in most often.
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I find what was wrong in my formula , the real odds was 21%(payout of 285k that represents appx 15% of "house adventage"). I went with DAX historical # instead of vols. A bit complex , but by the end the answers is pretty simple : in the last 100 days it was only 21 times when DAX moved<88 points ( mean of 4900 and 5075 strikes) in any 1 , 2, 3, 4 or 5 days of trading (including intraday hi-lo).
 
Quote from IV_Trader:

I find what was wrong in my formula , the real odds was 21%(payout of 285k that represents appx 15% of "house adventage"). I went with DAX historical # instead of vols. A bit complex , but by the end the answers is pretty simple : in the last 100 days it was only 21 times when DAX moved<88 points ( mean of 4900 and 5075 strikes) in any 1 , 2, 3, 4 or 5 days of trading (including intraday hi-lo).
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Gotcha... remember to use strike vols and not atm or strips. ATM vols will result in higher premiums-paid as the vol-smile is not modeled. Wasn't a huge-impact on the DAX as it was short delta position and you cannot isolate the time-series in terms of barrier probabilities.
 
Quote from Choad:

Slammin', risk!

Tagged a mil! Beer's on you this week... :cool:

Good trading.

C
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Thanks! Milwaukee's Best or PBR? I'll be at NYMEX for the week leading into Thanksgiving if anyone wants to grab a brew on me. [No MB or PBR will be served] :D
 
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