Option replication and exotics journal

[IV_Trader]

Quote from riskarb:

Not at all. I'd be interested in any statistical approximations.

OK then. I already know how do it : I will build touch position (via vanilla long options) with pre-set conditions:
1. Time=30 days
2. Must close position when Touch=true or one week later (whatever comes first)
3. Compare vanilla odds/payout to one R_A previous entries using the same strikes
Should be apples to apples.

 

[stock777]

I pretty much understand your response, though some of the other posts look like tryouts for the Greenspan "What did he just say" Award. ;-))

I saw something about OTB in there, who do you like in the double?

 

[riskarb]

Quote from IV_Trader:

OK then. I already know how do it : I will build touch position (via vanilla long options) with pre-set conditions:
1. Time=30 days
2. Must close position when Touch=true or one week later (whatever comes first)
3. Compare vanilla odds/payout to one R_A previous entries using the same strikes
Should be apples to apples.

I follow your logic, but there are some problems. 30d terms structure implies far less gamma in the vanilla, especially when approaching the strike. You're +curvature in gamma, but only holding approx 20% of the gamma you'd hold in the exotic.

Another problem with the 30d expiration is the higher vega. Although the position is only held for a week, the vanilla carries much greater vega, and too little gamma. The PnL curve will look similar, simply less-peaky but wider[platykurtic] when compared to the exotic payout.

 

[riskarb]

Quote from stock777:

I pretty much understand your response, though some of the other posts look like tryouts for the Greenspan "What did he just say" Award. ;-))

I saw something about OTB in there, who do you like in the double?

OTB = off the board

 

[IV_Trader]

Quote from riskarb:

I follow your logic, but there are some problems. 30d terms structure implies far less gamma in the vanilla, especially when approaching the strike. You're +curvature in gamma, but only holding approx 20% of the gamma you'd hold in the exotic.

Another problem with the 30d expiration is the higher vega. Although the position is only held for a week, the vanilla carries much greater vega, and too little gamma. The PnL curve will look similar, simply less-peaky but wider[platykurtic] when compared to the exotic payout.

I see what you are saying , I will run the test in couple time periods ( and one of them will be 8,9 or10). Riskarb , I need exact price of the DAX at the time of one of your previous trades , lets say for one of the Touch trade (I got the payout and Strike , but missing underline). Maybe you can give me one sample of all three variables (past trade or future) when you have some free time.
Thanks

 

[Trend Fader]

Here is a question.

Assuming the spot price of EURO is 100. Now we enter a no touch trade.. where Euro cant trade under 80 in the next 7 days. Assuming the risk to reward is 1:1.. so we make $100 if right and lose $100 if wrong. Now at the same time we short spot Euro so that each 1 point is +/- $5. Now we place stop loss on the euro short trade at 120 and place take profit at 100.

Now if I am correct the only way we can lose money on this trade would be Euro trades over 120 and then drops back to under 80... If this is true... then this is an extremely attractive trade!!!!! Is there something that i am missing.. is it possible to setup a trade like this with plain US vanilla options on futures that trade 24 hours like S&P's? Or is this type of risk profile trade only availabe via OTC market?

 

[riskarb]

Quote from Trend Fader:

Here is a question.

Assuming the spot price of EURO is 100. Now we enter a no touch trade.. where Euro cant trade under 80 in the next 7 days. Assuming the risk to reward is 1:1.. so we make $100 if right and lose $100 if wrong. Now at the same time we short spot Euro so that each 1 point is +/- $5. Now we place stop loss on the euro short trade at 120 and place take profit at 100.

Now if I am correct the only way we can lose money on this trade would be Euro trades over 120 and then drops back to under 80... If this is true... then this is an extremely attractive trade!!!!! Is there something that i am missing.. is it possible to setup a trade like this with plain US vanilla options on futures that trade 24 hours like S&P's? Or is this type of risk profile trade only availabe via OTC market?

The 80 no touch with spot at par would trade for >$99 on a $100 payout. Not a great r/r at 100:1. You need to be within one sigma to get the 1:1 r/r.

 

[Trend Fader]

Quote from riskarb:

The 80 no touch with spot at par would trade for >$99 on a $100 payout. Not a great r/r at 100:1. You need to be within one sigma to get the 1:1 r/r.

So what u are saying is that the scenerio is not realistic because in order to get the 1:1 risk to reward the market has to trade in way where it is very likely to hit 80 and 120?

If i am wrong.. can you please explain is simpler terms.. lol

 

[riskarb]

Quote from Trend Fader:

So what u are saying is that the scenerio is not realistic because in order to get the 1:1 risk to reward the market has to trade in way where it is very likely to hit 80 and 120?

If i am wrong.. can you please explain is simpler terms.. lol

I don't follow EUR vols very closely, but I'd imagine you'd need to price the no touch within 120 pips of spot to get 1:1

 

[Trend Fader]

Quote from riskarb:

I don't follow EYR vols very closely, but I'd imagine you'd need to price the no touch within 120 pips of spot to get 1:1

The example i competely made up.. the numbers themselves are kinda irrelevant... i was questioning the logic behind the trade..


--MIKE