Option replication and exotics journal

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I was short the GOOG 430 straddle; bought the shares at the close yesterday, 2x1 straddles over stock. Covered the stock/combo position with GOOG at 462 and 40%vol at a slight gain, only to see vols rise to 46% when the shares hit 470. Sold the Feb 460 combo at 45% vol and we closed the day just under the 40% vol-line. Great day to trade GOOG volatility. I think the vol^2 portends a retracement in the shares -- as a buddy stated today, the vols drive the stock.
 
Risk you mentioned doing a single barrier no touch under the short es position and also hedging another position by going long 60 contracts per handle and 100 contracts at a higher handle in order to accommodate gamma curvature (i think these numbers are right). How do you calculate how many futures to go long or short to effectively hedge and how do you deal with whipsaws and selling to cover a hedge when a market ceases an assault on a leg of say a double/single no touch or a short straddle/strangle?

Enjoying the ride as usual, thanks.
 
Quote from Prevail:

Risk you mentioned doing a single barrier no touch under the short es position and also hedging another position by going long 60 contracts per handle and 100 contracts at a higher handle in order to accommodate gamma curvature (i think these numbers are right). How do you calculate how many futures to go long or short to effectively hedge and how do you deal with whipsaws and selling to cover a hedge when a market ceases an assault on a leg of say a double/single no touch or a short straddle/strangle?

Enjoying the ride as usual, thanks.
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The risk to strike equates to a hedge req of 600 contracts at 16,400 on Nikkei futures. I discount this req for the possible delta-inversion. Of course the hedge req increases into the risk-strike due to the lack of an initial strong-hedge of 600 cars. I model the derivative[gamma slope] and arrive at a discrete hedge at 1/2/3 daily sigmas, or 3 sigmas based on the hourly cash chart. Currently the hedges are added more discretely, but these #s assume 80-point triggers if traded arbitrary and w/o the benefit of modeling gamma curvature.

I don't have the spreadsheet here, but it looks something like 40/95/155/280/420 [990] from an initial hedge of 40 at 16,400. I am roughly in-line with the original 600-req [570 w/the 280 add] until I add the final 420 contracts. I avert major whipsaw losses, but the end result is an increase in hedge of >50% when compared to the static 600 req. Anyway, disregard the 60 lot add mentioned in the prior post; I was referring to hedges 40 & 95, but hadn't computed it at the time. The 990 max hedge is still soft by $250k.

The 5 total hedge additions assume a small contract premium due to "anti-Merton" discontinuity. There is a strong possibility of gaps due what's happened in the US and EUR day sessions. This premium is < the initial discount for delta inversions.
 
Riskarb,

If you don't mind me asking, how many years have you been in the business?

Your knowledge is very impressive. Could you elaborate as to how does a regular trader get to your level of expertise ?

Cheers and good trading to you !
 
Quote from optionpro007:

Riskarb,

If you don't mind me asking, how many years have you been in the business?

I'm 39 now, been trading my account since I was in my late-teens; got killed by a Paine Webber reco to go long into the crash of '87. Started in options attempting to trade discount arbitrage, but that required better access to order flow than was available to me. I was trading verticals very close to expiration, 2-3 day positions. Was staked by my dad, which led to some OPM for neighborhood friends of the family.

Your knowledge is very impressive. Could you elaborate as to how does a regular trader get to your level of expertise ?

Thanks. I've read very little related to the subject as I prefer to work my own solutions. Although I've never read the book; Baird's "Option Market Making" seems very intuitive to me, from what I've glossed-over. Cottle to a lesser extent. I would say that Cottle's basic box-dissection is excellent for trading a large book. It's brief, and doesn't extend beyong boxes(to flys and horizontals) but it's a good read nonetheless.

Cheers and good trading to you !
 
Thanks Riskarb.

I probably didn't make myself clear, excuse me. I meant your development as far as to what instruments you starting trading with and which instruments you followed over the last 20 years.

To get to where you are, wouldn't somebody have to go through many different stages ?

Thanks !!

Quote from riskarb:

Quote from optionpro007:

Riskarb,

If you don't mind me asking, how many years have you been in the business?

I'm 39 now, been trading my account since I was in my late-teens; got killed by a Paine Webber reco to go long into the crash of '87. Started in options attempting to trade discount arbitrage, but that required better access to order flow than was available to me. I was trading verticals very close to expiration, 2-3 day positions. Was staked by my dad, which led to some OPM for neighborhood friends of the family.

Your knowledge is very impressive. Could you elaborate as to how does a regular trader get to your level of expertise ?

Thanks. I've read very little related to the subject as I prefer to work my own solutions. Although I've never read the book; Baird's "Option Market Making" seems very intuitive to me, from what I've glossed-over. Cottle to a lesser extent. I would say that Cottle's basic box-dissection is excellent for trading a large book. It's brief, and doesn't extend beyong boxes(to flys and horizontals) but it's a good read nonetheless.

Cheers and good trading to you !
More...
 
Quote from optionpro007:

Thanks Riskarb.

I probably didn't make myself clear, excuse me. I meant your development as far as to what instruments you starting trading with and which instruments you followed over the last 20 years.

To get to where you are, wouldn't somebody have to go through many different stages ?

Thanks !!
More...

Convert and discount arbitrage, risk arbitrage, equities, futures, exotic options. It's really not that time-consuming nor difficult. It doesn't require a hard-science background, but it helps.

Some pick it up very quickly, some never do. I know some very sharp ppl with hard-science backgrounds who can't get the concept of volatility, let alone the more advanced concepts.

I think the important thing is to not rush the process. Mastering the more exotic concepts aren't necessary to trade well. Learn p/c parity, synthetics, vol smile characteristics; and above all else, know your risk before making a trade.
 
Quote from riskarb:

The risk to strike equates to a hedge req of 600 contracts at 16,400 on Nikkei futures. I discount this req for the possible delta-inversion. Of course the hedge req increases into the risk-strike due to the lack of an initial strong-hedge of 600 cars. I model the derivative[gamma slope] and arrive at a discrete hedge at 1/2/3 daily sigmas, or 3 sigmas based on the hourly cash chart. Currently the hedges are added more discretely, but these #s assume 80-point triggers if traded arbitrary and w/o the benefit of modeling gamma curvature.

I don't have the spreadsheet here, but it looks something like 40/95/155/280/420 [990] from an initial hedge of 40 at 16,400. I am roughly in-line with the original 600-req [570 w/the 280 add] until I add the final 420 contracts. I avert major whipsaw losses, but the end result is an increase in hedge of >50% when compared to the static 600 req. Anyway, disregard the 60 lot add mentioned in the prior post; I was referring to hedges 40 & 95, but hadn't computed it at the time. The 990 max hedge is still soft by $250k.

The 5 total hedge additions assume a small contract premium due to "anti-Merton" discontinuity. There is a strong possibility of gaps due what's happened in the US and EUR day sessions. This premium is < the initial discount for delta inversions.
More...

Riskarb, thank you for the explanation.

If I’m understanding it should look like this:
Long 40 @ 16400
Long 95@16480
Long 155@16560
Long 280@16620
Long 420@16700

The first two positions were an average of about 60 each so close enough :D . Thanks to you I know what discontinuity is but what is anti Merton? Also, are you saying since Friday’s day sessions were so strong a gap could be likely on Monday? I can see the point is to start building a position rather than try to model gamma precisely, is this correct?

The thing that still throws me is what if the Nikkei gets to 16635 and then reverses as many indices are so mean reverting and you are long 570 cars. Do you hold and only make less of a profit as the payout occurs or is there a plan to scale out of the longs on the way down also?
 
I was using a linear example of adding hedge size. The actual calc would produce curvature. Yes, the whipsaws can be troubling, but are mitigated somewhat by the short holding period. I tend to reduce position size in much smaller increments; such as 10 lots every 30 to 40 points. None of this is cast in stone -- most of the time I have a directional bias and will avoid trading a strong hedge against that bias. The recent strength in JPY makes me hesitant to add any long hedge here, but I will add 100 tonight.
 
Riskarb

thanks very much for continuing on this very interesting thread, which has taught me a lot about exotics. I have so far avoided trading them, primarily because my options software (OptionVue) does not allow for modelling these types of options.

Is there any commercially available programme that you know of/recommend to do this, or do you use a proprietary programme? Unfortunately, I do not have access to either Bloomberg or Reuters which I believe provide this sort of analysis.

Rudi
 
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