Option replication and exotics journal

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Hey riskarb,

Couple of question please:

1) What does that position cost to put on in terms of haircut or margin? Or is there none since this is debit trade?

2) With exotics your counter-party allows you to set the date in which the trade will expire, correct?

3) Do they price these fairly?

4) What's the commission like?

Thx


Quote from riskarb:

SPX double barrier no touch -- 1200//1245
Premium: $50,200
Payout: $100,000 [includes prem paid]
Expires: Sep 15, 2005
Negative edge: $4,000

Will look to trading vanilla gamma into the barrier after some delta bleed.
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Quote from Dr. Zhivodka:

Hey riskarb,

Couple of question please:

1) What does that position cost to put on in terms of haircut or margin? Or is there none since this is debit trade?

No variation margin due to the debit-paid. There is no maint. req. into the binary condition. If either barrier is hit you lose the debit.

2) With exotics your counter-party allows you to set the date in which the trade will expire, correct?

Right, OTC conventions as in interbank fx. Resolution to the day.

3) Do they price these fairly?

Prices are generally good, and when they're leaning on me I pass -- I tend to spread the orders around as best I can, but there aren't a ton of ibanks making a market in this stuff. Such is life when trading a dealer-market. A good prime brokerage arrangement really helps. I price one quote against at least one other, as well as pricing against two or more models. I state the -edge with each trade based upon FairVal using a blended vol in the vanilla strips which correspond to roughly-equivalent strikes; i.e., I use the vanilla 1200p/1245c in the listed SPX vanilla as my vol-line. In this example it was an easy calc as I have equiv. listed vanilla strikes.

4) What's the commission like?

Thx

The commish is built into the market.
 
Quote from riskarb:

Thanks. Check out hoadley.net for single barrier pricing -- it's a free java applet.
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Thanks a lot for the heads up. Will use this for sure.
 
Nikkei double barrier no touch -- 12,000//12,900
Premium: 13,060,000Y
Payout: 22,000,000Y [includes prem paid]
Expires: Sep 16, 2005
Negative edge: 907,000Y

Gamma is dangerous in the Nikkei, but I've got some room to maneuver due to the blotter's mark to market. Wanted to get short some deltas as well. I am bumping-up against my self-imposed trading limits on index exotics, but will likely increase max debit to $500k next week, depending on how my flat to short direction plays-out.
 
Risk,

Have you thought about using Static Option Replication to hedge the entire range of your barriers at one time?

Though I don't if this will save you a lot of hassle and dynamic hedge risk since your expirations appear to be very short term in nature.
 
Quote from Dr. Zhivodka:

Risk,

Have you thought about using Static Option Replication to hedge the entire range of your barriers at one time?

Though I don't if this will save you a lot of hassle and dynamic hedge risk since your expirations appear to be very short term in nature.
More...

Replication is very costly. I can purchase dgamma/dS more cheaply in Dow barrier-touches, but it suffers due to corr and tracking on a narrow index. I would rather buy convexity in vanilla otc or listed-gamma for the 1-correlation, and that's why I've been trading the hybrids. I would enter the variance market if not for the give-up. Thus far I am up on primary and futures hedge, so I am generally pleased with the results.

My only concern is trading downside-gamma into the barriers through the purchase of vanilla straddles. Would prefer to be +dgamma, but the exposure can't be matched with vanilla strangles. Buying downside gamma is an issue, but mitigated by the large-gamma I am buying in the short term structures.
 
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