Option replication and exotics journal

Discussion in 'Journals' started by riskarb, Jul 14, 2005.

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  1. I thought I would start an Option replication journal, including some exotic option trades in FX and equity vol. Trades will focus on replicating intramarket-gamma in equity index and street volatility, as well as trading exotics in FX wtih truncated-payoff conventions.

    Only replication trades with the following conditions will be posted:

    *** Net +gamma[dgamma+]
    *** Net +vega
    *** Net +shadow-theta[convergence gains]


    *** Correlation risk -- large in street vol, small in index vol. Will try to maintain -- +gamma/+vega position > position-correlation risk.

    The exotics will consist of truncated payoff position[TPP]; knockin/out combos, touches/no touches[combos/singles].
  2. Trajan


    I look forward to it. It should be interesting.
  3. Thanks Trajan.

    ER2 dramatically underperformed the narrow-index markets. Corrs between the YM and ER2 were negative today, but leaves a potential opportunity for the August series; if/when the corrs return to the mid-80%s.

    Buying 2 Aug YM 10600 puts at 9.50% vol [105]
    Selling 1 Aug ER2 950 puts at 17.00% vol [7.90]

    Net position debit: $260

    Potential edge(s):

    Long vega
    Long gamma
    Short delta
    +dgamma position
    Long convergence -- from favorable ratio and delta position. +dgamma -- cheap vol equates to cheap gamma in otm options. YM vol at 750basis under ER2 provides for a +gamma curvature and gearing[significant +slope].


    Correlation was negative on the day. Such is the concern when trading narrow index markets like YM vs. a broad index like the ER2/RUT.

    Expect gains from favorable ratio and delta position to overwhelm correlation risks. Unlikely we'll see another opportunity to trade this spread at such favorable terms. Hope to see a double over the net debit paid by expiration. Will follow up as need be.
  4. Looking to be flat to long delta in EUR/USD due to tame-reaction to the blistering Retail data and CPI. The vol-skew is flat, so it was a toss-up whether to go long spot/risk-reversal or short spot/risk-conversion, but it more closely resembles a synthetic short straddle using exotics.

    *** Long 100k EUR/USD at 1.2082
    *** Short 200k EUR/USD touch exotic, struck at 1.2220, expiring July 22 at 10amEDT

    ***Long 70k EUR/USD touch exotic, struck below the recent lows at 1.2038

    To limit the confusion... the position loses $600 at the 1.2220 strike and earns approx. $2,600 at the lower strike{at expiration].

    I expect the lower[1.2038] strike to be hit resulting in a payout. With luck the EUR/USD will hit my long touch at 1.2038 and creep higher. In either case it resembles a bull synthetic short straddle with a long put. There is a lot of bleed in the greeks; too much so to break the position down any further.
  5. The "put" touch has an expiration of July 20
  6. Mr. Ignorance back again, :)

    What's an ER2 950 put. Aren't we around 660 right now?

    What are the bracketed numbers in your examples?

    I tried looking up the IV on IB's option trader and got radically different numbers. I could only get IWM on Ivolatility.com and they were around 15% IV right now.

    Rather than bother you with a ton of obvious questions -- from your point of view :) -- can you recommend somewhere I can read up on this type of trade? :)


  7. ozzy


    This stuff is over my head but it looks very interesting. Looking forward to reading more.

  8. I was thinking of the YM vols when I wrote the ER2 strike typo; it is indeed a 650put.

    Nelken's book is pretty thorough from what I hear:


    The vols were taken at the close between 4pm and 4:15pm EDT. The vols stated are close and were taken at the bid for the ER2 and the ask for the YM. The bracketed #s are the premiums-paid in the respective contracts.
  9. I'll be the first to admit that I only understand what you are doing generally, but...:)

    Can you define the risk/reward on this one for me. That ER2 position would make me a bit nervous.
  10. Prevail

    Prevail Guest

    Thanks Risk.
    #10     Jul 14, 2005
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