riskarb's trading journal

[momoneythansens]

Quote from riskarb:

The steepness of the ramp, due to simple proximity, has little to do with the gamma-convexity unless you're trading in the final moments before expiration. They work great if you've survived 80% of the holding period and can reach 80% of the max-gain on the vertical, but they're not a viable hedge if there is significant time remaining. Also, the gamma is reduced as you tighten strike width. Ok as a vol hedge, but gamma is the primary risk.

Well, my understanding is that a 1 tick wide vertical will replicate a European digital everywhere on the map of risk-neutral possible outcomes. Path-independence means only expiration risk profile replication is necessary from a static hedge point of view. This replication obviously doesn't hold for American digitals.

I'll never understand the need to replicate 100%... trading is about accepting risk. Any replication will entail significant edge-loss, correlation and risk-holes.

Agree, didn't mean to imply 100% replication was a good idea as that obviously negates any profit potential not to mention being wholly impractical!

However, from a purely academic point of view, it is useful to know that a 1 tick wide vertical is as close as you'll get to a European digital - and thus can help in terms of being an intuitive tool for pricing them, especially when taking skew into consideration.

To add to the discussion -- single and double barriers are +expectancy vanilla replications at fairval. Barrier-gamma is cheap, vanilla gamma is expensive.

This is clearly the reason to trade them!

The points I make above are all pertinent to European digitals not Americans. Bear with me, I'm not quite ready to have an intelligent conversation on those yet

MoMoney.

 

[riskarb]

Quote from momoneythansens:

Well, my understanding is that a 1 tick wide vertical will replicate a European digital everywhere on the map of risk-neutral possible outcomes. Path-independence means only expiration risk profile replication is necessary from a static hedge point of view. This replication obviously doesn't hold for American digitals.


Agree, didn't mean to imply 100% replication was a good idea as that obviously negates any profit potential not to mention being wholly impractical!

However, from a purely academic point of view, it is useful to know that a 1 tick wide vertical is as close as you'll get to a European digital - and thus can help in terms of being an intuitive tool for pricing them, especially when taking skew into consideration.



This is clearly the reason to trade them!

The points I make above are all pertinent to European digitals not Americans. Bear with me, I'm not quite ready to have an intelligent conversation on those yet

MoMoney.

I have an annoying habit of scanning posts and missing key statements/elements. The term European was somehow missed. Yes, the vertical is as close as one can get to the the payoff and greek profile on a PI/european.

I rarely trade PI/european exotics... none can be found in this or the exotic and replication journal. They're horrible neutral bets, unless you're long the gamma. I would overwhelmingly choose to be short american and long european-gamma; +PD/-PI. Difficult to price and expensive when neutral delta. They're in a class of exotics that include reverse knocks and other moronic-bets.

 

[Buy1Sell2]

Riskarb, are you better at trading these types of plays than you would be at simple directional trades? Do you have a track record (no need to post it), of both types of trades and feel more successful with this type?

 

[riskarb]

Quote from Buy1Sell2:

Riskarb, are you better at trading these types of plays than you would be at simple directional trades? Do you have a track record (no need to post it), of both types of trades and feel more successful with this type?

Most are neutral, but some carry substantial directional bias. The current SPX bull no touch is carries an soft-hedge. The $475,000 payout comes at a barrier-risk of $200,000 due to the weak ES hedge. The notional-size can be calculated based upon one sigma to expiration -- the position is essentially a synthetic straddle -- in this case the notional risk roughly equates to 135,000 shares of SPY.

 

[rallymode]

Quote from riskarb:

Most are neutral, but some carry substantial directional bias. The current SPX bull no touch is carries an soft-hedge. The $475,000 payout comes at a barrier-risk of $200,000 due to the weak ES hedge. The notional-size can be calculated based upon one sigma to expiration -- the position is essentially a synthetic straddle -- in this case the notional risk roughly equates to 135,000 shares of SPY.

typical riskarb answer, makes you go "huh?WHAT?"

 

[fader]

Quote from riskarb:

The hedging is often discretionary, but more often I solve for a strong hedge that allows for a b/e at the barrier strike. Often I will hedge weakly when taking a directional bet [long in the above SPX no touch] or when predicting the shape of the distro to expiration.

riskarb, two questions are of real interest to me:

1. with respect to your current spx trade, for example - whether you had a strong hedge or weak hedge - how do you decide when to take it off if the market starts moving against the hedge (i.e. when you covered partial at 1271) ? and how many times will you allow for putting it back on / taking it off since it eats into your profits, i.e. what is the general methodology?

2. what structure do you use for insurance against a black swan type event? do you have something permanent in place, do you somehow figure it into each of your trades?

i appreciate you taking your time and being patient with those of us who want to learn more about this area - personally, i have found that better knowledge of options has dramatically enhanced the quality of my trading, especially understanding and applying continuous probability concepts.

also, by the way i know in Germany the banks offer knock-ins / outs to the retail public (kind of funny to think mom and pop trading exotics over there ), i haven't heard of any equivalent retail products in the U.S., are you aware of any? thx.

 

[momoneythansens]

Quote from fader:

also, by the way i know in Germany the banks offer knock-ins / outs to the retail public (kind of funny to think mom and pop trading exotics over there ), i haven't heard of any equivalent retail products in the U.S., are you aware of any? thx.

I believe when PUT options were first introduced they were "exotic".

Many facets such as the payoff and the "bet" nature of some exotics make them somewhat more comprehensible to the retail market than vanilla options.

Then again, the less transparent features such as hedge parameters etc. are arguably harder to grasp.

Riskarb metioned earlier that the CBOT have introduced binary options on the Fed Funds Rate. Perhaps this is a sign of more things to come.

Other than that the retail trader has access to www.betonmarkets.com and www.clickoptions.com etc.

However, these tools are more for entertainment purposes IMO. There are multiple limitations to their usefulness.

MoMoney.

 

[riskarb]

Quote from fader:

riskarb, two questions are of real interest to me:

1. with respect to your current spx trade, for example - whether you had a strong hedge or weak hedge - how do you decide when to take it off if the market starts moving against the hedge (i.e. when you covered partial at 1271) ? and how many times will you allow for putting it back on / taking it off since it eats into your profits, i.e. what is the general methodology?

I haven't reduced the hedge -- I would've updated the journal had I reduced the hedge. Any gamma trading reflects time to expiration, d/g position, market breadth, gut feel, global VaR etc...

2. what structure do you use for insurance against a black swan type event? do you have something permanent in place, do you somehow figure it into each of your trades?

There is no risk on the option beyond the barrier. The only risk is to a futures or r/r hedge. There is the potential for windfall profits into the direction of the hedge.

i appreciate you taking your time and being patient with those of us who want to learn more about this area - personally, i have found that better knowledge of options has dramatically enhanced the quality of my trading, especially understanding and applying continuous probability concepts.

also, by the way i know in Germany the banks offer knock-ins / outs to the retail public (kind of funny to think mom and pop trading exotics over there ), i haven't heard of any equivalent retail products in the U.S., are you aware of any? thx.

There aren't any offered in the US

 

[fader]

Quote from momoneythansens:

Riskarb metioned earlier that the CBOT have introduced binary options on the Fed Funds Rate. Perhaps this is a sign of more things to come.

thx, i missed this, will be interesting to see if this becomes a volume product.

 

[fader]

Quote from riskarb:

Quote from fader:

2. what structure do you use for insurance against a black swan type event? do you have something permanent in place, do you somehow figure it into each of your trades?

There is no risk on the option beyond the barrier. The only risk is to a futures or r/r hedge. There is the potential for windfall profits into the direction of the hedge.

[/i]

thx riskarb - i guess i was referring more to a trade like your nikkei trade, for example - you are short 1 future against 3 puts - if there is a big down move / gap, you potentially have 2 unhedged puts in the money with delta close to -1.0 (assuming you are unable to hedge / market halts); conversely if the market is up big (less likely of course), you are unhedged with 1 short future, less the premium on the puts - i am assuming a situation where you will not be able to hedge dynamically as you would normally want to, i.e. trading halted / liquidity is temporarily suspended.