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i'm an intern in bank at Morocco that sells vanilla options on EUR/USD , EUR/MAD , USD/MAD , it s using delta hedging strategy to cover they're position . But because of the switch to floating exchange rate of morocco in the next months , the bank is wondering how it will be cover its book of options and which strategy is optimal in this case , is there any technique to simulate this ? What volatility should i consider in this case ? PS : Options are sold OTC

Thanks in advance

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  • $\begingroup$ Any help please ? $\endgroup$
    – SquaredCircle
    Commented Mar 8, 2017 at 9:52
  • $\begingroup$ Try reading Natenburg or Taleb. There was another question about volatility considerations here $\endgroup$
    – rupweb
    Commented Mar 8, 2017 at 12:21
  • $\begingroup$ Probably my comment doesn't answer your question, but I doubt that the switch from MAD fixed to floating will impact EURUSD option hedging. Who knows what MAD volatility will be, presumably higher than usual for a month or two? $\endgroup$
    – rupweb
    Commented Mar 8, 2017 at 12:36

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The question of how to hedge an option portfolio on multiple underlyings against tail risks is not an easy one, nor what with a single answer.

There are probably two big risks: - a period of increased volatility in all currencies versus MAD until the MAD settles down that the market believes to be right - a big one-off P&L on a big move on MAD versus all other currencies.

For the latter, you could do an analysis where you assume all non-MAD exchange rates fixed and you let EUR/MAD vary from -20% to +20% (or whatever bounds people are expecting). Reevaluating the book with all xxx/MAD implied levels from those and then looking at the P&L and greeks versus the level should give you an idea of whether you're comfortable with the risks. You could look at vega here and estimate the impact of that on your P&L, but my expectation (without knowing anything of your book) is that the gamma impact from a big one-off move to a new level of trading might dwarf whatever your vega P&L might do.

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