# Tag Info

33

Many of them are on my website at emanuelderman.com. Others I probably have anyway. Feel free to email me

12

E.g. on Monday you get forced to buy some Friday expiry OTM puts, say 95% strike S&P weeklies. Of course, you go and buy some delta against them to "hedge" yourself. Next thing you know, the the market tanks. Unfortunately, by Friday it's only down 3.5%, so it's does not fall far enough to reach the strike. So, on Friday expiration, you are out your ...

11

I had read some of them; actually, it does not exist an on-line library that collected them (or, better, it existed here, but it seems the website does not work anymore). I reported here below some of them that you did not find: More Than You Ever Wanted To Know* About Volatility Swaps Model Risk The Volatility Smile And Its implied Tree Enhanced Numerical ...

10

You are missing the futures basis and roll cost. Futures expire, and need to be rolled into the new expiry. The basis is not static and can vary considerably, depending on the specific underlying and contract. Quants may have a hard time to appreciate this but the basis is not at all fully quantifiable at all times: It can hugely vary entirely due to shifts ...

9

By delta hedging you are saying that you have a view on the path and the volatility of the option you are trading, but not on its direction; in your case, that being short delta. From a theoretical perspective, all options are priced fairly and not delta hedging simply increase the variance of your payouts. In your example, selling a call and delta ...

8

Skew "arbitrage" is a pretty broad term. When you are trading the skew, there are 3 principal risks (or sources of P&L, if you will): (a) the actual change in the slope of the skew in the implied space. e.g. if you are trading 95% strike against 105% strike and your underlying stays in place, all of your instantaneous P&L would be due to the changes ...

8

the problem is that the pay-off has discontinuous first derivative. Try a contract with pay-off that is twice differentiable and it will probably work. The problem is that all the value comes from the tiny number of paths within $\Delta S$ of the strike, and these paths have huge value. This is a well-known problem. As the bump size goes to zero, the ...

8

The point is the following: Delta, $\Delta$, is defined as $\frac{\partial C}{\partial S}$, where $C$ is the value of the call option, and $S$ is the price of the underlying asset. So, given that the value of a call option for a non-dividend-paying underlying stock in terms of the Black–Scholes parameters is $$C = N(d_{1})S - N(d_{2})Ke^{-rT},$$ $$\Delta ... 8 There's no easy answer to your question, as noob2 pointed out. You can look online for info from Universa. That fund does exactly what you are asking: https://www.universa.net/riskmitigation.html Of course, post a crash, such as the one we just experienced, the cost of hedges is larger than it is prior to such events. Understand that you aren't going ... 8 With difficulty and high costs and secretively. Successful ones are the ones that are able to do it more cheaply. This is also the reason for their secretiveness: prices would go up. The costly but straightforward approach would be to buy equity index puts. However, I don't think anyone here can or will explain how you can tail hedge at scale significantly ... 7 You are absolutely right, I would say that how the interview question was posed and the example given is very misleading, if not outright incorrect. Here is why: Hedging does not increase your risk in this particular example: You take on delta exposure by buying the short dated option outright. Thus buying/selling underlying (put/call) in any case will ... 7 You are long a vanilla option, so long gamma (positive gamma). If the stock price decreases, so does the delta of your option. Since you short-sold the stock to hedge, you now have short-sold too much since delta has decreased. As a consequence, you must buy back some stock. 7 You would be over hedged in your call position if it was delta neutral before the stock cratered. Since you are long delta on the call, you would have shorted stock to make the original position delta neutral. When the stock fell, your long call delta would have fallen, and you would buy to cover some of your short stock hedge. However, being long the ... 6 The differential equation has a trend due to the interest rate. When you discount you take this trend away:$$ \frac{d}{dt} (e^{-rt}Z_t) = -re^{-rt}Z_t + e^{-rt} \frac{d}{dt}Z_t = e^{-rt}\frac{1}{2}S_t^2\Gamma_t(\hat{\sigma}^2-\beta_t^2) $$Z doesn't appear on the rhs anymore and you can integrate$$ e^{-rT}Z_T - e^{-r0}Z_0 = \int_0^T e^{-rt}\frac{1}{2}...

6

Due to the lack of a carry arbitrage, VIX futures are actually the direct hedge for VIX Index options

6

There are more ways to approach this but the method I propose should work reasonably well in practice, especially if you increase the number of assets you hold. Calculate the beta of the stocks you're holding with respect to an index Buy $N_f$ (sell when $N_f$ is negative) future contracts on that index $N_f$ can be calculated as $$N_f = \frac{\beta_T - \... 6 Your simulation is basically fine, though you need to discount in USD. For hedging purpose, you need to use the instruments available in USD. Let S=\{S_t, \, t\ge 0\} be the stock price process in EUR, X=\{X_t, \, t\ge 0\} be the exchange rate process from one unit EUR to units USD, r_f and r_d be interest rates in EUR and USD. Moreover, let B_t^f=... 6 A general hedging strategy Let assume that S_1(t) and S_2(t) are the price processes of your 2 stocks and that they follow a Geometric Brownian Motion (GBM):$$\forall \, i \in \{1,2\}, dS_i(t) =\mu_iS_i(t)dt + \sigma_iS_i(t)dW_i(t)$$We assume both stocks have an instant correlation of \rho:$$dW_1(t)dW_2(t)=\rho dtLet also V(t) be the value ... 6 You're right that the "real" greeks of a digital option are unwieldy, e.g. delta is zero everywhere except at the barrier where it is an impulse. So sell-side trading desks model/price digital options as tightly struck call/put spreads that will sit and play nicely with the rest of the book. Here's a simple example: let's say a bank sells a digital call on ... 6 I would do as follows: A) First do PCA on an arbitrage-free monthly curve (assuming the most granular contract you will use is individual months). To ensure no arbitrages, you will need to drop out certain contracts, I would drop the most illiquid ones. To give you an example, if you are in Dec, you might see Jan, Feb and Mar quoted, but also Q1. In this ... 6 Presumably the option can be exercised for intrinsic at any point. Note the interviewer asked for a static hedge using the stock, not a dynamic hedge. Hence you must find a buy and hold portfolio that will always give you at least the value of the option (if you’re short it which I suppose is the question) until it is exercised. Note that the maximum ... 5 This is usually called Pin Risk. It's difficult because there is a high degree of uncertainty regarding the whether the options you sold are exercised or not. If you don't hedge, your short options could be exercised and you are left with risky net short position in the underlying. If you hedge and your short options are not exercised, then you have a long ... 5 Let V(t, r_t, S_t) be the convertible bond price at time t, where \begin{align*} dS_t &= S_t(r_t dt + \sigma dW_t^1)\\ dr_t &=\kappa(\theta-r_t)dt+\Sigma dW_t^2, \end{align*} and where \{W_t^1, \, t\ge 0\} and \{W_t^2, \, t\ge 0\} are two standard Brownian motions with d\langle W^1, W^2\rangle_t = \rho dt. Then, \begin{align*} &\ dV(t, ... 5 \require{cancel}\text{PnL} = -[P(t+\delta t,S+\delta S)-P(t,S)] + rP(t,S)\delta t + \Delta(\delta S - rS \delta t + q S\delta t)$$Assuming a pure diffusion, at the order 1 as \delta t \to 0$$P(t+\delta,S+\delta S) = P(t,S) + \frac{\partial P}{\partial t}\delta t + \frac{\partial P}{\partial S}\delta S + \frac{1}{2}\frac{\partial^2P}{\partial S^2}(\...

5

The empirical relationship between the futures price $F$ and the spot price $S$ is $$F = S e^{b\tau}$$ where $\tau$ is the time to expiry, and $b$ is the empirical basis, i.e. the number that makes the equation hold, given by $$b = \frac{1}{\tau}\log(F/S)$$ It can be compared to the theoretical basis, $$b_{\rm theor} = r - q$$ where $r$ is the ...

5

This is a slightly extended version of my comment that summarizes the main result of the reference that I provided. This problem is discussed in detail in Chapter 12 of Wilmott (2006), which is based on the paper Ahmad and Wilmott (2005). See also the related Question 9 in Carr (2005). In your case, you are selling and delta hedging the option using the ...

5

The quoting convention must be explained somewhere in your book. For Eurodollar futures, this convention is 100 - yield, 92 means the yield is 8% per annum, so for one quarter you need to divide this discount by 4 to get the price (100% - (8% × (3month/12month)) = 100% - 2% = 98%

5

Yes, you can say they are traded on listed options, but only for a few limited markets, and not that liquid relative to options on a single asset. For instance, the commodity futures space, there are options on commodity spreads listed, and a strike of 0 would be the same as an exchange option. These options have some liquidity in energy and grain markets,...

5

If it is a single name CDS, the transaction leaves the bank short the credit spread of that bond vs a risk-free bond in the same currency. To go long the spread, the bank would i) buy the same CDS from another bank or ii) sell short the same bond, and get rid of general interest rate risk by going long a risk-free bond (or interest rate swap) of the same ...

5

Well, it's a topic which actually should have its own book dedicated. Unfortunately, existing literature is rare or not practical enough. Let me at least try to provide some key ideas and challenges you should consider when hedging this kind of structure. First, let's start with the question: How not to hedge an autocallable? What is not going to work is ...

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