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Option replication and exotics journal
- Thread starter riskarb
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I'll be incorporating hybrid butterfly positions in the journal
Sounds interesting. Looking forward to that.
The only method of trading the hybrid "long" butterfly is to trade the position as a short g/v vanilla body + long g/v binary wing-barrier
Is the binary wing barrier going to be a double touch option or two separate touch options?
Buying the long binary will not really protect you as well as vanilla wings, as the payoff is fixed, right?
but they allow for a lot of gamma trading flexibility on the vanilla position if/when the wing-event is reached
What do you mean by "gamma trading flexibility"?
What are you planning on doing when/if one of the barriers is reached? Any adjustement strategies you've been considering?
The most compelling reason for trading the short gamma hybrid butterfly is the short convexity via the short vanilla body straddle.
So if I get this right : your long gamma position via the k/i options combined to a decreasing short gamma on the vanilla straddle should enable you to have a confortable situation if/when approaching a barrier, as the whole position then becomes much less short gamma.
Your wings being exotic k/ins, they have way more gamma-sensivity when approaching a barrier than vanilla wings, is that the characteristic you would like to cash in on?
Quote from kalashnicac:
Sounds interesting. Looking forward to that.
Is the binary wing barrier going to be a double touch option or two separate touch options?
A double touch.
Buying the long binary will not really protect you as well as vanilla wings, as the payoff is fixed, right?
Correct, but the binary will be structured so that the payoff will be > the notional risk on the vanilla under two to three sigma
What do you mean by "gamma trading flexibility"?
What are you planning on doing when/if one of the barriers is reached? Any adjustement strategies you've been considering?
Hedging into the vanilla convexity is preferred, declining gamma position and mean reversion potential. There are more ways to skin a cat with convex-payoffs.
So if I get this right : your long gamma position via the k/i options combined to a decreasing short gamma on the vanilla straddle should enable you to have a confortable situation if/when approaching a barrier, as the whole position then becomes much less short gamma.
Yes, good point, the leverage is out of the system, but the exposure is delta position -- looking to earn on the binary > the $delta into the continuing exposure
Your wings being exotic k/ins, they have way more gamma-sensivity when approaching a barrier than vanilla wings, is that the characteristic you would like to cash in on?
yes... excellent questions
Sounds interesting. Looking forward to that.
Is the binary wing barrier going to be a double touch option or two separate touch options?
A double touch.
Buying the long binary will not really protect you as well as vanilla wings, as the payoff is fixed, right?
Correct, but the binary will be structured so that the payoff will be > the notional risk on the vanilla under two to three sigma
What do you mean by "gamma trading flexibility"?
What are you planning on doing when/if one of the barriers is reached? Any adjustement strategies you've been considering?
Hedging into the vanilla convexity is preferred, declining gamma position and mean reversion potential. There are more ways to skin a cat with convex-payoffs.
So if I get this right : your long gamma position via the k/i options combined to a decreasing short gamma on the vanilla straddle should enable you to have a confortable situation if/when approaching a barrier, as the whole position then becomes much less short gamma.
Yes, good point, the leverage is out of the system, but the exposure is delta position -- looking to earn on the binary > the $delta into the continuing exposure
Your wings being exotic k/ins, they have way more gamma-sensivity when approaching a barrier than vanilla wings, is that the characteristic you would like to cash in on?
yes... excellent questions
Risk Arb,
Nice journal. If you can get a moment, can you swing by REFCO Spot page and see how their exotics compare in price to what your seeing by going overseas. They make it easy for small size to play. I am just wondering what kind of edge I am giving up.
If you had to pick one model to model exotics and look at their risk parameters which would it be and can you state a good reference on it.
Lastly, with the huge slope of Gamma on exotics near barriers, have you looked at gamma scalping at all with exotics. The gamma seems cheap in your posts so there may be some action there.
Well almost lastly, to change subject. When you are trying to convert a combo to a fly, have you looked at or know any reference on the cost hedging the 3 sigma event with verticals or longs? Does it make since to? The average theta loss is about 1 week to convert a combo at a positive expectancy. I am guessing it would turn into about 2 weeks if you hedge the 3-4 sigma event.
Thanks
Swampy
Nice journal. If you can get a moment, can you swing by REFCO Spot page and see how their exotics compare in price to what your seeing by going overseas. They make it easy for small size to play. I am just wondering what kind of edge I am giving up.
If you had to pick one model to model exotics and look at their risk parameters which would it be and can you state a good reference on it.
Lastly, with the huge slope of Gamma on exotics near barriers, have you looked at gamma scalping at all with exotics. The gamma seems cheap in your posts so there may be some action there.
Well almost lastly, to change subject. When you are trying to convert a combo to a fly, have you looked at or know any reference on the cost hedging the 3 sigma event with verticals or longs? Does it make since to? The average theta loss is about 1 week to convert a combo at a positive expectancy. I am guessing it would turn into about 2 weeks if you hedge the 3-4 sigma event.
Thanks
Swampy
Quote from swampy:
Risk Arb,
Nice journal. If you can get a moment, can you swing by REFCO Spot page and see how their exotics compare in price to what your seeing by going overseas. They make it easy for small size to play. I am just wondering what kind of edge I am giving up.
quite a bit of edge is lost with refco. assume to give up an additional 10% with refco
If you had to pick one model to model exotics and look at their risk parameters which would it be and can you state a good reference on it.
finite difference[FDM] or MC for euro-variants. I use the MBRM UNIVDRV add-in. Look into Heston's model. I can't find my pdf right now and it's no longer available on the web. I will see if I can find it.
Lastly, with the huge slope of Gamma on exotics near barriers, have you looked at gamma scalping at all with exotics. The gamma seems cheap in your posts so there may be some action there.
Double no touches always look cheap. Inversely, the double touches always look expensive. There is very little dgamma or vega in either. I'd rather use convex hedges, but will continue to hedge with futures into the discontinuous-gamma. Look at the mirror-image double no touch sensitivities. Paying 30% on a double NT is inferential to 70% for the double touch. Large gamma and small vega. Lastly, I give up significant-edge on these 7d options
Well almost lastly, to change subject. When you are trying to convert a combo to a fly, have you looked at or know any reference on the cost hedging the 3 sigma event with verticals or longs? Does it make since to? The average theta loss is about 1 week to convert a combo at a positive expectancy. I am guessing it would turn into about 2 weeks if you hedge the 3-4 sigma event.
It's very difficult to hedge the outlier with verticals. Plus, you're -dgamma/dx when using a vertical. My experience is to define the hedge using the implied distro from the atm straddle and choose wing strikes accordingly. You'll likely need to hold the straddle unhedged into expiration waiting for your hedge opportunity. IOW, it's a function of absolute vols/surface[too low].
Thanks
Swampy
Risk Arb,
Nice journal. If you can get a moment, can you swing by REFCO Spot page and see how their exotics compare in price to what your seeing by going overseas. They make it easy for small size to play. I am just wondering what kind of edge I am giving up.
quite a bit of edge is lost with refco. assume to give up an additional 10% with refco
If you had to pick one model to model exotics and look at their risk parameters which would it be and can you state a good reference on it.
finite difference[FDM] or MC for euro-variants. I use the MBRM UNIVDRV add-in. Look into Heston's model. I can't find my pdf right now and it's no longer available on the web. I will see if I can find it.
Lastly, with the huge slope of Gamma on exotics near barriers, have you looked at gamma scalping at all with exotics. The gamma seems cheap in your posts so there may be some action there.
Double no touches always look cheap. Inversely, the double touches always look expensive. There is very little dgamma or vega in either. I'd rather use convex hedges, but will continue to hedge with futures into the discontinuous-gamma. Look at the mirror-image double no touch sensitivities. Paying 30% on a double NT is inferential to 70% for the double touch. Large gamma and small vega. Lastly, I give up significant-edge on these 7d options
Well almost lastly, to change subject. When you are trying to convert a combo to a fly, have you looked at or know any reference on the cost hedging the 3 sigma event with verticals or longs? Does it make since to? The average theta loss is about 1 week to convert a combo at a positive expectancy. I am guessing it would turn into about 2 weeks if you hedge the 3-4 sigma event.
It's very difficult to hedge the outlier with verticals. Plus, you're -dgamma/dx when using a vertical. My experience is to define the hedge using the implied distro from the atm straddle and choose wing strikes accordingly. You'll likely need to hold the straddle unhedged into expiration waiting for your hedge opportunity. IOW, it's a function of absolute vols/surface[too low].
Thanks
Swampy
Exotic blotter tally: +$3,000 to date
Excludes open positions:
Dax 4825//5040 double barrier no touch + short 20 FDAX from 4900 [8/17] ... expect a touch tomorrow, but it might dodge the bullet. Debit is hedged with futures.
USD/CAD 1.2095 single touch [8/19] ... saw 1.2045 today and had a gamma-trigger in at 1.2050, no sell on spot. Selling 1mm resting if we get to 1.2040
Nikkei 11650//12580 double barrier no touch [8/19] ... was nicely short delta, now somehwat neutral and I expect to earn the payout on this one barring a complete meltdown. Will hedge with futures below 11900
Excludes open positions:
Dax 4825//5040 double barrier no touch + short 20 FDAX from 4900 [8/17] ... expect a touch tomorrow, but it might dodge the bullet. Debit is hedged with futures.
USD/CAD 1.2095 single touch [8/19] ... saw 1.2045 today and had a gamma-trigger in at 1.2050, no sell on spot. Selling 1mm resting if we get to 1.2040
Nikkei 11650//12580 double barrier no touch [8/19] ... was nicely short delta, now somehwat neutral and I expect to earn the payout on this one barring a complete meltdown. Will hedge with futures below 11900
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