I have often wondered what kind of risk restrictions do traders of options in Hedge funds have but have not managed to find any information on this matter. I presume there must be some kind of measure for a Portfolio Manager (PM) to decide whether to approve their trades or not. However, I cannot find any data about what kind of risk measure would be used. Let me give an example. Let us say I want to buy an FX barrier option, taking a directional bet. Would then the PM come to me and say: I think you have too much Delta/Gamma/Vega etc.? To be more specific, what is the relationship between risks (e.g. Delta/Gamma/Vega, Theta) and the potential return that a typical Hedge Fund or trading desk accept? Is there some literature on this? What kind of option strategies are typically used to minimize risk-adjusted return?

  • $\begingroup$ otherwise said, what are classical methods/option strategies to minimize risk for given market view. I would really be interested in seeing some examples $\endgroup$
    – fwd_T
    Mar 29 at 12:19
  • $\begingroup$ It is quite a complicated problem, which is a good reason IMHO you would not use a barrier option to make a simple directional bet, but use a vanilla option (we make X if we are right we lose Y if we are wrong) or even better a linear instrument. Make a bet on direction only and not on volatility, path, option market liquidity and what else. $\endgroup$
    – nbbo2
    Mar 30 at 17:55
  • $\begingroup$ @nbbo2 this is interesting. I heard this before. So in a nutshell you mean that if you want a spot directional bet, you'd want to have an as pure-as possible spot exposure (e.g. not mixed with vol exposure as in the case of barriers or even vanillas). Nonetheless, is there some write-up about such general considerations? $\endgroup$
    – fwd_T
    Mar 30 at 20:56


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