Well the problem with being short straddle in vanilla is the open ended risk if market runs away.. the short synthetic straddle via exotics takes care of the runaway part and makes the straddle a fixed bet .. I dont see how I can setup a long straddle in exotics? Can it be done somehow?
No, my point was to generalize. They're not fungible, and there is no way to make them so. There is a vanilla/exotic parity with ki/ko options, but those are analogs. No, it can't be done; any more so than replicating a short straddle. It's a misnomer to term the exotic position as a short straddle, but it's most representative. In either event, they're stat-vol + gamma plays. The pros are numerous; asym-r/r, trimodal PnL, etc... the flip-side of the coin is the null-bet if the barrier is reached. IMO, the pros dramatically-outweigh the cons as the risk is clearly defined and solved at the strike. If there is any practical info to be gleaned from this current-tangent; it is that the strong-hedge single no touch is often used to great effectiveness into a directional-trend. Possiblity for convergence gains, b/e result at the strike, windfall beyond the strike. In that sense, it's akin to a long backspread traded at a significant edge-credit. Downside is that a vanilla straddle reaches peak of the distro at the body strike; we b/e at the body strike in the exotic. Hence our neutrality is something >barrier strike unless the hedge is overwhelming. Into the barrier it's a no lose -- away from the barrier it replicates a vanilla straddle.
Excellent explanation. I agree the no touch strong hedge is not similar to a true vanilla short straddle by any means... there are many differences as you noted very well.. Where I was getting at with our discussion.. is trying to find the types of exotic trading strategies that the pros use.. basically types of plays you cant make with vanilla that can be done or are more favaorible in exotics. So far with my limited education I am starting to see the no touch strong hedge as one of the most powerfull... thats probably why you used in most of your trades done on this journal. --MIKE
Any FX trades u see in the horizon?.. can u explain how u trade the FX maket and what types of strategies u use? Do u look at the crosses with high carry interest trades.. like aud/jpy or nzj/jpy? --THanks...
Yeah, Mike... I will be rolling some stuff over tomorrow in FX. I'd taken the week off for the holiday. The trades are carry trades hedged with exotics; primarily yen carry trading. I will go into more detail when I post the trades to the journal.
looks like the use of vanilla spread (credit or debit) is very close to exotic position (touch/no touch) , especially for the short time period. If you get 2.5$ credit for 5 point spread (instead of no touch) it's like 1:1 odds/payout in exotic. Move beyond the barrier strike become irrelevant/less relevant . I am still looking for "real" example , but spreads are apples to apples as it's can get , IMO
You'd need to sell an atm spread to receive a 1:1 risk/reward. Nowhere near to the 1sigma otm for an exotic trading at FairVal. Of course, at 1sigma you lose the entire debit on the binary at the barrier. The barrier is priced at 1:1 at something less than 1sigma, but used for illustration. They cannot be replicated with vanilla.