Course dates
The primary focus of this 3 day program will be to examine the dynamic risk characteristics of options from a trader/client perspective. 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-linearity’s of vanilla and exotic options and the implications for their management. The program will finally focus on 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 course assumes a general understanding of ‘vanilla’ derivative instruments and whilst not based upon a detailed theoretical or mathematical approach, does require basic mathematical fluency.
Over
3 days, you will:
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Analyze vanilla and exotic options
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Examine option pricing and risk characteristics
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Gain an understanding of how options can be used in directional and non-directional strategies
- Understand different hedging and trading applications
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 the Black-Scholes pricing model
- Option price determinants (strike, underlying price, volatility, term, interest rate, dividend)
- Black (1976) formula for options on forwards
- Advantages and shortcomings of the Black-Scholes framework
- Rationalizing distortions to the Black-Scholes model framework
– Non-continuous hedging
– Stochastic volatility
– Kurtosis
– Change in Greeks resulting from large standard deviation moves in underlying
- Numerical methods: Binomial lattice models
- Arbitrage-free derivation of a generalized binomial model
- Modeling spot and forward processes
- 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 realized volatility measures
- Volatility estimation: analysis of data samples; sample sizes; weighting sample data
- Volatility surfaces
– Volatility smiles, skews
– Volatility term structure effects
- Volatility properties
– Stochastic volatility
– Mean reversion
- Stochastic volatility models
– Heston stochastic volatility model
- Volatility analysis
– Volatility relative value analysis (implied vs. realized)
– Skew interpretation and analysis
- Volatility trading strategies
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
- ‘Sticky strike’ effects
- Expiration effects
- Liquidity effects
- Execution risk (risk vs. agency execution)
- Gamma; 2nd order option price sensitivity
– Interpreting gamma
– Gamma characteristics of in-, at- and out-of-the-money options
– Long and short gamma – risks and opportunity
– Impact of gamma on delta hedge management
– Implied vs. realized volatility exposure
– Maximizing profitability from gamma management
- Theta; option price time decay
– Theta as cost of carry
– Inter-relationship between Theta, Gamma
- Vega; implied volatility risk sensitivity
- Rho; Interest rate sensitivity
- Understanding and actively managing inter-relationships between option price sensitivities
- Active management of portfolio delta, gamma and vega risks
- Higher order risks
– Delta time decay (Charm)
– Gamma sensitivity (Speed, Color)
– Vega (Vanna, Vomma)
- Skew risk
– Risk reversals
- Limitations of option ‘Greeks’
– Discontinuities in market price behavior
– 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 maximize profitability
Day 2
Option strategies
- Directional (Delta) and non-directional (volatility/time decay) strategies
– Bullish, bearish directional strategies
- High/low volatility
- Risk/reward (limited vs. unlimited risk strategies)
– Bullish, bearish volatility strategies
- Risk/reward (limited vs. unlimited risk strategies)
- Directional trading and arbitrage strategies
– Put-Call parity
– Conversions and reversals
– Synthetic forwards and options
– Combinations
– Synthetic lending/borrowing
– American options; assignment risk
- Vertical Spreads
– Call and put (Bull and Bear) spreads
– Trading Rationale
– Pricing; impact of skew effects
– Risk characteristics
- Delta hedging
- Gamma; risk reversal
- Skew risk
- Non-directional (volatility/time decay) trading strategies
- Calendar Spreads
– Rationale
– Volatility term structure (calendar skew) impact
– Sensitivities; volatility/time decay exposure
- Straddles, strangles and butterfly spreads
- – Structure and rationale
– Risk characteristics
– Skew effects
– Volatility trading; dynamic management
- Client trading and hedging strategies
- Risk reduction strategies
– Puts, collars
– Put spreads
- Yield enhancement strategies
– Over and under-writing strategies
- Volatility and correlation trading strategies
– Straddles
– Dispersion trading strategies
Case study: structuring option strategies (spreads, collars, butterflies); examination of risk characteristics and position risk management through time
Interest rate options
- Interest rate caps and floors
- Swap options
- Hybrids: collars; corridors
- Pricing and hedging caps and floors
- Interest rate option pricing models
- Risk management
– Delta hedging caps and floors
– Gamma and Vega management; risk bucketing
- Practical applications of interest rate options
- Asset and liability risk management
- Embedded caps and floors; capped FRNs, Minimax FRNs, Reverse FRNs
- European, Bermudan callable and puttable swaps
Case study: corporate interest rate exposure management with options
FX options
- Fundamental properties of currency options
- Market conventions, terminology, price quotation basis (base vs. quoted)
- Pricing Vanilla FX options – Garman-Kohlhagen model
- Volatility surfaces for FX options
Equity options
- European and American styles
- Single stock and index options
- Basket (index) options
– Correlation impact on valuation
– Implied vs. realized correlation
Commodity options
- Pricing models for commodities
- Backwardation effects and hedging considerations
- Mean reversion effects
Day 3
New generation products
- Volatility and variance swaps
– Mechanics of variance swaps
– Pricing and hedging
- Uses and applications of variance swaps
– Volatility trading
– Dispersion trading
Exotic options
- Exotic option classification
- Pay-off structure
- Motivations and applications of exotic options
- Pricing and valuation issues
- Black-Scholes, analytical models; advantages and shortcomings
- Numerical methods (Binomial, Trinomial lattice models,
- Monte Carlo simulation)
- Modeling considerations for exotic option payoffs
- Skew effects
Barrier options
- Pricing and valuation issues
- Risk management of barrier option risks; risk reversals
- Application of barrier options in trading and hedging strategies
- Embedded barrier options in equity structured products (e.g. bonus certificates, reverse CBs)
Case study: barrier option hedging strategies: forward plus, knock-in collars, knock-out forwards
Average rate (Asian) options
- Mechanics of average rate options
- Pricing and risk management characteristics
- Currency hedging with Asian options
Digital (binary) options
- Pricing of digital options
- Risk management of digital options; replication and hedging
Applications: range accrual notes, contingent premium options
New York Hotel, New York, United States
This program takes place on a non-residential basis at a New York hotel. 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.
As with all Euromoney Training programmes on-site administrators are with you throughout the programme to ensure smooth administration and group interaction.
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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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Course dates