Option replication and exotics journal

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Quote from riskarb:

Trading the underlying directionally? I much prefer exotics to vanilla, although they're not nearly as transparent. Nobody is forced to trade; if the vega as expressed by spot vols is too cheap I can pass on the quoted market. I am willing to give-up a day or two in edge for the opportunity to trade short gamma into limited risk.

Hedging is done with conventional, exchange product. So I see it as the best of both worlds. OTC, limited risk short gamma + trading hedges at fairval.
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Good argument. But can short gamma ever be truly limited risk and even if so is that beneficial given the skeewed risk/reward dynamics.

Also isn't it quite difficult trading the hedge?
 
Quote from CPTrader:

Good argument. But can short gamma ever be truly limited risk and even if so is that beneficial given the skeewed risk/reward dynamics.

Also isn't it quite difficult trading the hedge?
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Well yeah... there is zero-gamma above the barrier. The risk reward has nothing to do with absolute risk.
 
Just have to say great trading on a variety of instruments. I tried trading a variety of instruments at once (stocks, options, FX) but it was way too overwhelming! Commend you on having great analysis done!

-Mahras
 
Quote from CPTrader:

Also isn't it quite difficult trading the hedge?
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The risk of hedging barriers is discontinuity near the strike; i.e., a hit of a no touch that was well-defended and an immediate reversal in which your spot hedge is exposed.

The hedging maths are easier with truncated/convex payoffs.
 
Quote from riskarb:

The risk of hedging barriers is discontinuity near the strike; i.e., a hit of a no touch that was well-defended and an immediate reversal in which your spot hedge is exposed.

The hedging maths are easier with truncated/convex payoffs.
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Thx for taking the time to respond!
 
Quote from riskarb:

OIH short/risk conversion:

Sold 111.54 on OIH
Sold Sep 110 puts at $3.00 [30.5%vol]
Bought Sep 115 calls at $2.38 on BOX [28.5%vol]

$.62 in net credit. Approx. $.35 edge due to -skew. Risk is capped at 115. Risk conversion was traded against a pre-existing short in OIH. Traded the conversion with OIH shares at 111.54L.
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Can you explain how you make $ on this position?
 
Quote from Trend Fader:

Can you explain how you make $ on this position?
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There is roughly 35 cents in edge over simply shorting the OIH. The r/r is symmetrical, but capped. It's a small risk-reward short with edge on the split-conversion. The edge is defined by the put/call vols.

There is $2.16 in bear-potential. There is ($2.84) in upside risk, but the trade has a +expectancy expressed by the 200basis in vol-credit -- selling 3000vol, buying 2800vol.

To compare; the upside risk into a flat vol-surface would incur approx 35 cents in additional risk.

Thnx Mahras
 
Quote from CPTrader:

Also isn't it quite difficult trading the hedge?
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Look at a chart of today's action in the USD/CAD. There were basically no prints above 1.2093 until 1.2112 on spot. Perfect example of gap risk into binaries. Take a look at the small gap at 1.2093 to above 1.2095. The barrier would've been triggered with continuing risk on the short spot position.

Best to get flat-hedge at a conservative trigger below the barrier, than to be exposed to discontinuity risk. In this case, some 20-odd pips to get any size done. There are no guarantees.
 
Riskarb..

Just curios.. do a lot of hedge funds play similar directional betting strategies like the ones in this journal... or are they more interested in non direction..?
 
I've attempted to stay neutral direction, but it's impossible to maintain neutrality. Every tick is a moving-target. Binary options are defined by their truncated payoffs. Vanillas by their convexity. Betting is a term best suited to Vegas[the one in NV, not the vol-sensitivity]. Nearly any trading decision can be replicated more efficiently with an exotic.
 
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