Course dates
Course overview
'Options School' provides you with a comprehensive and detailed analysis of options – pricing, risk characteristics, and their dynamic behaviour in the context of the management of a portfolio of options. The course is a combination of proprietary risk strategies combined with flow trading and market making responsibilities. The primary focus is to examine the dynamic risk characteristics of options from a trader/market maker’s perspective, addressing issues at the sales - client interface, operating in a professional and pro-active capacity in advising and executing client orders.
Module 1: Options Trading Workshop
The agenda initially addresses vanilla options, and through a combination of classroom-based teaching combined with computer-based simulations and exercises, offers a thorough and practical understanding of option pricing and risks, and how options can be used in directional and nondirectional strategies, together with their dynamic hedging implications.
Particular emphasis is placed on gaining an understanding of the dynamic interaction between option price determinants, the impact on portfolio risk of higher order non-linearities of vanilla and exotic options and the implications for their management. The course will also provide a detailed analysis of other sources of risk - liquidity risks, execution risks, expiration risks, and the risk implications of operational differences between listed options and their OTC counterparts.
Module 2: Exotic Options
On the last two days, the course will look at exotic options, and will provide a similar perspective on their pricing and risk characteristics, in order to understand the motivations and rationale for their usage in a variety of different hedging and trading applications.
The marketplace for exotic options has grown at a dramatic rate in recent years, fuelled in part by the growth of structured products across traditional and alternative asset classes, and the increasing use of exotic derivatives within corporate and institutional applications. Exotic derivatives have become commonplace in the creation of such innovative structures, lowering costs and increasing the flexibility in tailoring risk profiles to suit end user views and expectations.
Summary of course content
- Analyse vanilla and exotic options
- Build option pricing and valuation models
- Gain practical experience of option risks and dynamic hedging
- Use options to express trading views
- Gain an understanding of how options can be used in directional and non-directional strategies
- Understand different hedging and trading applications
Methodology
The training will comprise a combination of classroombased teaching combined with computer-based (Excel-based) simulations and exercises, to gain practical exposure to key principles and concepts. Delegates will each receive copies of all spreadsheet software for their own use after the programme.
Part of the training agenda is allocated to running an option portfolio real-time simulation.
Pre-course reading material will be distributed to delegates prior to attendance at the course.
Prerequisite
The course assumes a general understanding of ‘vanilla’ equity derivative instruments and requires
basic mathematical fluency.
Who should attend this training course?
- Traders and dealers
- Derivatives sales personnel
- Structurers
- Risk managers and risk controllers
- Corporate account officers
- Asset managers
- Corporate treasury personnel
Supporting publication
Day 1
Option valuation – principles and option pricing models
- Continuous stochastic processes; Brownian motion
- The Black-Scholes option pricing model
- Underlying concepts, assumptions and derivation of Black-Scholes
- Option price determinants (strike, underlying price, volatility, term, interest rate, dividend)
- Advantages and shortcomings of the Black-Scholes framework
- Rationalising distortions to the Black- Scholes model framework
- Non-continuous hedging
- Stochastic volatility
- Kurtosis
- Discontinuous movements: limitations of ‘Greeks’
- Numerical methods: Binomial and trinomial lattice models
- Arbitrage-free derivation of a generalised binomial model
- American and other path dependent options
- Volatility and time parameters in the binomial model; value determinants, price sensitivities
- Simulation methods of option valuation - Monte Carlo
Case Study: Building option pricing models; valuation of European, American option styles
Volatility
- Understanding volatility; the role of volatility in option pricing; volatility as an ‘asset class’
- Historic, implied and realised volatility measures
- Volatility analysis
- Volatility relative value analysis (Implied vs. realised)
- Volatility cones
- Skew interpretation and analysis
- Volatility properties
- Stochastic volatility
- Mean reversion
- Volatility estimation: GARCH models
- Volatility surfaces
- Volatility smiles and skews
- Volatility term structure effects
- Rationalising distortions to the BSM framework
- Non-continuous hedging
- Volatility skew and Kurtosis
- Problems with fitting the volatility smile dynamically
- Accounting and modelling for Stochastic volatility
- Vanna-Volga approach to constructing volatility surfaces
- Sticky strike and sticky delta approaches
- Quantifying the value of Volga, Vanna risks
- Local volatility modelling (Dupire etc.)
- Stochastic volatility (SV) modelling
- Heston, Bates
- SABR (Hagan et al.)
- Combining local and Stochastic volatility modelling
- Stochastic skew modeling (Carr et al.)
Option risks; hedging and risk management of option positions
- First order price risks: delta, vega, theta, rho, phi
- Delta hedging and risk analysis
- Dynamic risk management using delta
- Delta hedging an option portfolio
- Limitations and risks inherent in delta hedging
- PIN risk
- Expiration effects
- Liquidity risk
- Vega
- Implied volatility risk
- Vega characteristics
- Smile and skew risks: Sega and Rega
- Theta; option price time decay
- Theta as cost of carry
- Inter-relationship between Theta, Gamma
- Rho; interest rate sensitivity
- Understanding and actively managing interrelationships between option price sensitivities
- Active management of portfolio delta, gamma and vega risks
- Gamma
- Interpreting Gamma
- Gamma characteristics of in-, atand out-of-the-money options
- Long and short Gamma - risks and opportunity
- Impact of Gamma on Delta hedge management
- Implied vs. realised volatility exposure
- ‘Shadow’ Gamma
- Maximising profitability from gamma trading and management; gamma ‘scalping’
- Other higher order risks
- Delta time decay (charm)
- Gamma sensitivity (speed, colour)
- Vanna and Volga risks
- Management of higher order risks
- Risk reversals in management of skew (Vanna) risk
- Butterflies in management of smilke (Volga) risk
- Limitations of option ‘Greeks’
- Discontinuities in market price behaviour, option risks
- Expiration trading
- Strategies for managing risk when ‘Greeks’ experience large, discrete changes
- Stress testing and portfolio scenario analysis; identifying potential future risks
Case study: Dynamic management of option risks in a single option position/portfolio context; delta hedging and the analysis of trading p/l over a trading horizon. Exercise will involve managing position
Gamma in order to attempt to maximise profitability.
Day 2
Option strategies
- Trading and risk management strategies
- Rationale for using options
Directional trading and arbitrage strategies
- Put-call parity
- Conversions and reversals
- Synthetic forwards and options
- American options; managing assignment risk
- Vertical spreads
- Call and put (Bull and Bear) spreads
- Trading rationale
- Pricing; impact of skew
- Risk characteristics
- Delta hedging
- Gamma
- Skew risk
- Box spreads
- Synthetic lending/borrowing
- Arbitrage
- Risk reversals
- Trading volatility skew
- Management of Vanna risk
Non-directional (volatility) trading strategies
- Calendar spreads
- Rationale
- Volatility term structure (calendar skew) impact
- Sensitivities; volatility/time decay exposure
- Straddles and strangles
- Structure and rationale
- Risk characteristics
- Skew and smile effects
- Dynamic management
- Butterflies
- Vega convexity trading
- Management of Volga risk
- Dispersion trading
- Correlation trading
- Monetising implied vs. realised correlation
- Practical challenges in dispersion trading
- Dynamic risk management
- Yield enhancement strategies
- Over and under-writing strategies
- What is an optimal tenor for yield enhancement strategies
Risk management strategies
- Rationale for using options vs. outright hedges
- When is it rational to use options for hedging?
- Structuring tailored hedges with options
- Hedging strategies with options
- Collars
- Spreads
- Seagulls
- Participating forwards
- FX TARNs and target redemption forwards
Case study: Structuring option strategies (spreads, collars, butterflies); examination of risk characteristics and position risk management through time.
Embedded option strategies
- Embedding options into structured products
- Long and short volatility structured products
- Yield enhancement structured products
- Callable bonds and notes
- Reverse convertibles
- Inverse FRNs
- Capital guaranteed notes
Interest rate options
- Generic European style interest rate caps and floors
- Conventional pricing methods: Black (1976) model
- Why do markets use this model? Avantages and disadvantages
- Calibration to a volatility surface
- Pricing and hedging caps and floors
- Stochastic term structure models (BDT, LIBOR market model)
- SABR model
- Risk management
- Delta hedging caps and floors
- Gamma and Vega management; risk bucketing
- Practical applications
- Asset and liability risk management
- Embedded caps and floors; capped FRNs, Minimax FRNs,
- Reverse FRNs
- Swaptions
- Pricing swaptions: Black vs. term structure models
- European and Bermudan style swap options
- Calibration of swaption volatility surfaces
- Compatability and consistency with cap pricing
- Option embedded swaps
- Extendible and cancellable swaps
(European, Bermudan styles)
Day 3
FX options
- Fundamental properties of currency options
- Market conventions, terminology, price quotation
- Pricing vanilla FX options
- Volatility surfaces for FX options
- Vanna-Volga approach to constructing volatility surfaces
Equity options
- European and American styles
- Single stock and index options
- Basket (index) options
- Correlation impact on valuation
- Implied vs. realised correlation: Dispersion trading
Commodity options
- Pricing models for commodities
- Backwardation effects and hedging considerations
- Mean reversion effects
Volatility and variance products
- Volatility and variance swaps
- Mechanics of variance swaps
- Pricing and hedging
- Skew sensitivity
- Listed option strike availability
- Volatility (VIX, VSTOXX) futures
- Conditional and corridor variance swaps
- Definition; specifications
- ‘Upside’ and ‘Downside’ variance swaps
- Impact of skew on pricing; hedging considerations
- Uses and applications of variance swaps
- Volatility trading
- Dispersion trading
- Managing conditional volatility exposure (skew risk)
- Convexity trading
Case study: Pricing variance swaps; calculation of profit/loss for unconditional and conditional
variance swaps
Day 4
The mechanics of exotic options
- Exotic option classification
- Pay-off structure
- Path dependency (strong and weak)
- Exercise timing
- Order
- Decision dependency
- Multivariate dependencies
- Motivations and applications of exotic options
- Vanilla options and their limitations
- Customised and complex pay-off structures
- Flexibility
- Risk management applications; managing corporate exposures
- Cost comparison (Exotics versus vanilla alternatives)
- When are simple or exotic option strategies optimal?
- Pricing exotic options
- Practical problems in modelling exotic option pay-offs
- Path dependency
- Skew risk and pricing effects
- Model calibration: How to adjust for smile and skew effects
- Vanna-Volga approach to constructing volatility surfaces
- Local volatility models
- Advantages and shortcomings
- Stochastic volatility models
- Exotic option risk characteristics
- Hedging higher order moments of risk
- Skew sensitivity in exotics
- Discontinuous risk behaviour; limitations of using ‘Greeks’ in hedgin
Barrier options
- Overview of types (knock-ins and knock-outs; single and double barriers)
- Pricing and valuation of Barrier options
- Numerical (tree) methods of Barrier option pricing
- Pricing double barrier options and other variants
- Impact of varying barrier parameters on performance, cost
- Pricing using volatility surface
- Hedging Barrier options
- Risk sensitivities and their characteristics
- OTM Barriers
- Replication/Hedging
- Change in Greeks through time
- ITM Barriers
- Replication/Arbitrage bounds
- Change in Greeks through time
- Higher order sensitivities
- Applications of Barrier options
- Trading and hedging applications
- Rationale for barrier options - when to use and when not to use barrier options
- Structured barrier option strategies
- Barrier structures (forward plus)
- Knock-in cylinders
- Knock-out forwards
- Knock-out collars
- Applications of barrier options in
structured notes
– Equity bonus notes and certificates
– Twin-win certificates
– Reverse convertibles
Case Study: Constructing and pricing Barrier option structured hedging strategies; Structured
product embedded barrier options.
Digital (binary) options
- European and American ‘one touch’ styles
- Contingent premium options
- Pricing of digital options
- Adapting the Black-Scholes analytical approach
- Hedging and risk management of digital options
- Dynamic Delta hedging - limitations
- Gamma, Vega, Theta behaviour
- Higher order moments of risk; skew risk
- Replication using risk reversals
- Inadequacies of Black-Scholes theory in practice
- Applications of digital options:
- Trading applications - motivations for using digital options
- Contingent premium options
- ‘Range accrual’ structured notes; range accrual swaps
- Digital caps and floors
- Term sheet examples (interest rate, FX, hybrid examples)
Path dependent options - average rate options
- AROs (Average Rate Options) and ASOs (Average Strike Options)
- Mechanics of average rate options
- Geometric vs. arithmetic averages
- Pricing of the Asian options:
- Continuous averaging and discrete averaging
- Partial averaging: weighted and unweighted samples
- Analytical models
- Numerical solutions
- Hedging Asian options
- Risk sensitivities
- Dynamic replication using Vanilla options
- Practical applications of Asian options
- Hedging corporate exposures with Asian options
- Practical examples of the motivations and rationale for the use of Asian options
- Asian tails; embedded Asian options
- e.g. structured equity linked bond
Case Study: Pricing Asian options; structured product applications
Day 5
Path dependent options - lookback, cliquet and reverse cliquet options
- Definitions
- Pay-off types:
- Fixed and floating strike
- Discrete and continuous sampling of maximum/minimum
- Pricing and valuation issues
- Motivations for use - applications and examples
Multi-asset options
- Basket options
- Spread options
- Outperformance, ‘Best of’’ and ‘Worst of’ option styles
- Pricing methodologies
- Single factor and multi-factor approaches
- Impact of basket parameters (volatility, correlation) on pricing
- Where can we find correlation data from? Sources of implied correlation
- Hedging and risk management of multi-asset options
- Risks characteristics
- Cross Gamma - correlation risk
- Dynamic management of correlation risk
- Uses and applications of multi-asset options
- Basket options
- Hedging and trading spread risk
- Minimising cost and maximising yield enhancement with multi-asset options
- Structured product applications:
- CMS Spread linked notes
- ‘Best of’ and ‘Worst of’ structured products
- Altiplanos
- Multi reverse convertibles
- Hybrid structured products
Quanto options
- Pricing quanto options
- Replication approach
- Analytical approach
- Pricing parameters - correlation and volatility inputs
- Hedging quanto derivatives
- Correlation and volatility risks
- Dynamic correlation risk management
- Applications of Quanto options
- Foreign equity/domestic currency options
- Structured notes with quantoed payoffs
Embedded exotic options - structured products
- Rationale for issuers and investors
- Yield enhancement
- Capital protection
- Tailored investment strategies
- Financial engineering; creating and analysing structured debt
- Interest rate linked structured products
- Callable/puttable bonds
- Range accrual structures
- Exotic path dependent structured notes (LIFTs, Snowballs etc.)
- TARNS and other path dependent structures
- Equity linked structures
- Bonus certificates
- Multi-asset structures
- Reverse convertibles
- Hybrids
- FX structured products
- Forward plus, knock out forwards, knock in cylinders
- PRDCs
- Range accrual structures
Case study: Delegates will reverse engineer a number of structured products as well as creating and pricing a range of structured product types, across all main asset classes.
Hilton Hotel Singapore, Singapore, Singapore
This programme takes place on a non-residential basis at Hilton Hotel Singapore. Non-residential course fees include training facilities, documentation, lunches and refreshments for the duration of the programme. Delegates are responsible for arranging their own accommodation, however, a list of convenient hotels (many at specially negotiated rates) is available upon registration.
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Graham Dudlyke
Graham Dudlyke is a highly experienced derivatives consultant who has held senior positions in a number of major financial institutions in London and New York. As Vice President of the Arbitrage Trading Group at Chemical Bank, Graham was responsible for management and marketing of interest rate option trading, managing a portfolio of interest rate caps, floors and swap options. As an Associate Director of Mitsubishi Finance, London, he gained considerable experience in trading portfolios of swaps and options, and in risk management and financial engineering, including structuring new issues of debt and creating structured assets.
As Manager of SE Banken's Global Derivatives Trading Group, he held overall responsibility for swaps, options and fixed income portfolio trading and risk management, new product development, and corporate and institutional marketing of structured debt products. Graham lectures internationally on all aspects of derivatives and fixed income and is highly respected for his practical market approach to product structuring and applications. Graham holds an MBA from Imperial College, London and an MA in Chemistry from Oxford University.
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Interested in holding this course in-house? Please fill out your details and a member of our team will be in touch with more information.
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Course dates