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bigbenny2010
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Gamma for Exotic option

January 26th, 2011, 1:18 pm

Is there any one who knows how to test or evaluate the sign of Gamma for the exotic option? what would be the stratégie for controlling the risk, when the gamma change the sign?
 
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frenchX
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Gamma for Exotic option

January 26th, 2011, 1:39 pm

I know that the gamma of an exotic option is not always positive :example down and out call (for long maturity close to the barrier the gamma is negative).up and out call (for short maturity close to the barrier the gamma can be very negative).I advise you to read the book "Dynamic Hedging" from Taleb about that.
 
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daveangel
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Gamma for Exotic option

January 26th, 2011, 3:16 pm

QuoteOriginally posted by: frenchXI know that the gamma of an exotic option is not always positive :you don't say .....
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frenchX
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Gamma for Exotic option

January 26th, 2011, 6:40 pm

And I won't talk about cliquet, napoleons and "more path dependant than that you die" contractsKeep in mind that even a portfolio of vanilla options can have a negative gamma.
Last edited by frenchX on January 25th, 2011, 11:00 pm, edited 1 time in total.
 
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daveangel
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Gamma for Exotic option

January 26th, 2011, 7:23 pm

Quote And I won't talk about cliquet, napoleons and "more path dependant than that you die" contracts no please don't Quote Keep in mind that even a portfolio of vanilla options can have a negative gamma. well a short vanilla position can have -ve gamma
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frenchX
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Gamma for Exotic option

January 26th, 2011, 7:48 pm

Ok Dave you won but at least I will mention this paper the subtle nature of cliquet option by Paul WilmottTo refocus on the simple portfolio of vanillas the problem is when you have both long and short positions. I don't think that hedging each individual options is feasible in pratice (for portfolio with a big span of options I mean). If you have a big portfolio with a lot of options on different companies but in the same sector you may try to make a "global hedge" with the correlated index but I don't know how this idea is good in practice.Moreover there is a strong link between the gamma and the volatility. In the BS world Vega=sigma*S*(T-t)*gamma so since the gamma is linked with the vega and since it's well known that the volatility is strongly correlated with the stock price then you should also hedge your options for volatility change with another options on the same underlying , variance swap, volatility swap (be carefull to the convexity adjustment) and options or futures on VIX.Also keep in mind the idea of static hedging (not a so bad idea in my opinion ).
Last edited by frenchX on January 25th, 2011, 11:00 pm, edited 1 time in total.
 
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daveangel
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Gamma for Exotic option

January 26th, 2011, 8:11 pm

QuoteOriginally posted by: frenchXOk Dave you won but at least I will mention this paper the subtle nature of cliquet option by Paul WilmottTo refocus on the simple portfolio of vanillas the problem is when you have both long and short positions. I don't think that hedging each individual options is feasible in pratice (for portfolio with a big span of options I mean). If you have a big portfolio with a lot of options on different companies but in the same sector you may try to make a "global hedge" with the correlated index but I don't know how this idea is good in practice.Moreover there is a strong link between the gamma and the volatility. In the BS world Vega=sigma*S*(T-t)*gamma so since the gamma is linked with the vega and since it's well known that the volatility is strongly correlated with the stock price then you should also hedge your options for volatility change with another options on the same underlying , variance swap, volatility swap (be carefull to the convexity adjustment) and options or futures on VIX.Also keep in mind the idea of static hedging (not a so bad idea in my opinion ).what does this have to do with risk reversals in exotic options ?
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frenchX
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Gamma for Exotic option

January 26th, 2011, 8:25 pm

Just gaving some infos to the guy about the topic of hedging.Actually what is your comment Dave ? How do you efficiently hedge exotic option in pratice ?
 
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bigbenny2010
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Gamma for Exotic option

January 26th, 2011, 8:30 pm

yes, I actually have the same question for dave
 
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daveangel
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Gamma for Exotic option

January 26th, 2011, 9:13 pm

QuoteOriginally posted by: frenchXJust gaving some infos to the guy about the topic of hedging.Actually what is your comment Dave ? ?well my problem is gratuitously silly comments likeQuote Also keep in mind the idea of static hedging (not a so bad idea in my opinion and the others that I have highlighted thus far.Quote How do you efficiently hedge exotic option in pratice and I am still waiting to find out something about the topic that has not been taken off the internet
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frenchX
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Gamma for Exotic option

January 27th, 2011, 7:06 am

Ok ...So despite the fact that is taken from the Internet I advise the original poster to have a look on Exotic option lecture by AvellanedaThe first part explains nicely the gamma problem with a case study with a digital option. He also gives the basic idea of static hedging for this kind of exotics.For the gamma problem of exotic option, even if it's not directly related have a look at the books of Jim Gatheral (the chapter of barrier options and if you want the following one on exotic cliquet) and Paul Wilmott (vol 3 static hedging and cliquet study).Reading those chapters may help you bigbenny2010. Moreover since you are a student I advise you to not only read these chapters but to have a look at the whole book .So I'm done here.
 
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daveangel
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Gamma for Exotic option

January 27th, 2011, 7:20 am

QuoteSo I'm done here.Does this mean you are leaving Wilmott ?
knowledge comes, wisdom lingers
 
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frenchX
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Gamma for Exotic option

January 27th, 2011, 7:42 am

QuoteOriginally posted by: daveangelQuoteSo I'm done here.Does this mean you are leaving Wilmott ?I'm only leaving this thread.Funny to see how people are in bad mood nowadays (you seem to be in a bad mood, I am too and if you go to the OT it's WAR with people like Farmer, Ppauper, Fermion, Amin and so on). And sincerely, just to focus back for the last time on the original topic, since I think you are an experienced trader (at least regarding to your answers to technical trading posts) how option traders in bank manage this gamma sign risk practically?
 
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BramJ
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Gamma for Exotic option

January 28th, 2011, 11:04 am

As for the OP question: please explain a bit more clearly what you want. Assessing the sign of gamma of an exotic option? Are you interested in cutting-edge numerical stuff for high-speed evaluation? Are you interested in the basics of how gamma is computed? Or are you just interested in learning the global behaviour of gamma of various exotic options?As for the management of a exotics book, I think you need to differentiate between managing an overall book which will have gamma changing with time and level of undelrying and the management of specific cases in such a book where gamma get's very large due to - for example - an option approaching a barrier. For the overall management, I think most common is running scenarios where you bump underlyings/vols/time to some levels to see how your greeks look in that case. Based on this + how happy a trader with his position given his opinion on the market, a trader might decide to change his exposure by hedging with options. In the markets I work in, you see almost only vanillas trading OTC (so hedging happens with those). In theory, static hedging is nice there, in practice however, on a book with a lot of different undelryings and a lot of different exotics, my experience is just hedging with vanillas on roughly the right levels (which you know because you know what the big positions in your book are). For example, suppose I sell some autocallables, that contain a down-in-put at maturity, I'll probably just sell some puts against this (it gets a little more sophisticated as just selling some puts, but definitely not as sophisticated as looking at an optimal static hedge).As for the management of a being close to a barrier or digital level (this is typically where your gamma blows up): hold your breath, cross your fingers and pray is not the worst of strategies. Alternatively, depending on size, there are some games that are being played in the market of course (sst). Also, you could assign a probability to a barrier being hit, and having a look at how much you gain or lose when you are 1% below versus 1% above the barrier. Based upon those, you could decide to do some delta hedging against such a barrier? to FrenchX: I obviously cannot explain what causes - what is according to you - daveangel's bad mood. However, after your first post in this thread, I almost published the same kind of reply as he did but I hit the delete button at the last moment as I thought it wasn't worth it and it was just me who was annoyed. However, it seems not so let me explain. Personally, I get annoyed because:1. your first replies contain a lot of links and other noise (like your thoughts on the subject) which might be tangential and to some extent related to the OPs question, but don't answer his question.2. your replies show that you probably understand a lot of the theoretical foundation of derivative pricing, but demonstrate a clear lack of understanding of the basics from a practical point of view (your comment "remember that a portfolio of vanillas also can have a negative gamma" shows very clearly that your thinking way to theoretical about this and lack any practical experience).3. Because of the above + the contents of your numerous posts I get the impression that your participation on this forum has to do with a careermove that you want to make sooner or later. That's just as good as a lot of other reasons to participate in a forum to me, but please keep yourself confined to subjects where you actually can add some real value.
 
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bigbenny2010
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Joined: December 22nd, 2010, 4:13 pm

Gamma for Exotic option

January 29th, 2011, 7:27 am

many thanks BramJ, the original thinking is that since the sign of gamma for a trader is very important, therefore "how to Assess the sign of gamma of an exotic option" came out of my mind. Nice to read your comment. Seems there is certain difference between "book" and "reality". I have another quesntion "what are the most important factors to evaluate derivatives positions (today and under different market conditions) in reality? maybe it is too complex, but just some ideas.
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