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BLOBY
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Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 25th, 2009, 1:10 pm

An article published 2 years ago ... but still relevant.My question is : HOW DO YOU HEDGE THAT PRODUCT (TIMER OPTION) ?? --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------"Societe Generale Corporate and Investment Banking (SG CIB) has developed a new type of option that allows buyers to specify the level of volatility used to price the instrument. Called a timer call, the product is designed to give investors more flexibility and ensure they do not overpay for an option.The price of a vanilla call option is determined by the level of implied volatility quoted in the market, as well as maturity and strike price. But the level of implied volatility is often higher than realised volatility, reflecting the uncertainty of future market direction. In simple terms, buyers of vanilla calls often overpay for their options. In fact, having analysed all stocks in the Euro Stoxx 50 index since 2000, SG CIB calculates that 80% of three-month calls that have matured in-the-money were overpriced."High implied volatility means call options are often overpriced. In the timer option, the investor only pays the real cost of the call and doesn't suffer from high implied volatility," says Stephane Mattatia, head of the hedge fund engineering team at SG CIB in Paris.Under the timer call, the buyer can specify an investment horizon and an expected volatility. A variance budget is then calculated (target volatility squared, multiplied by the target maturity), which forms the basis for the option's price. Once the variance budget is consumed, the option expires.For example, if an investor buys a timer call with a target of three months and believes volatility over this period will be 20, the variance budget would be 0.01 (0.2 x 0.2 x (91.25/365)). Once this is consumed - in other words, once realised volatility squared multiplied by the number of expired days divided by 365 is more than the variance budget - the option would expire.If the investor is correct and realised volatility is 20, the option will mature in exactly three months. If the realised volatility is lower than expected (say, 15), the option will expire at a later date (around five months). Likewise, if realised volatility is higher (say, 30), the option will expire sooner (around 1.3 months).SG CIB piloted the product with a small number of hedge fund clients in April, and is now rolling it out more widely to its client base. "The reception has been very positive, and we've already traded on stocks and indexes in Europe and the US, as well as on Asian indexes," says Alastair Beattie, managing director in the hedge fund group at SG CIB in London.The first trade was at the end of April with a hedge fund client. The fund unwound existing plain vanilla calls on HSBC with a June expiry and rolled them into an HSBC timer call. At the time, the implied volatility on the plain vanilla call was slightly above 15%, but the client set a target volatility level of 12%, a little higher than the prevailing realised volatility level of around 10%.By rolling into a timer call, the hedge fund reduced its premium by 20%. Since the inception of the trade, the realised volatility has been around 9.5%. If it remains at this level, the maturity of the timer call will be 60% longer than the original vanilla call. SG CIB has now traded on 20 underlyings for a total notional of EUR300 million."This product is going to have an application for anyone trading options where they find the implied volatility expensive," says Beattie. "The normal evolution for new products is that hedge funds will be first to move, then it will be picked up by other types of investors. Any sophisticated investor with a view on the volatility of an underlying as well as its price evolution, will be able to use it.""
 
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fomisha
Posts: 67
Joined: December 30th, 2003, 4:28 pm

Timer options

March 25th, 2009, 8:57 pm

why not use black-scholes-merton?
Last edited by fomisha on March 24th, 2009, 11:00 pm, edited 1 time in total.
 
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BLOBY
Topic Author
Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 26th, 2009, 6:40 am

but how do you hedge and replicate this product ?
 
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EndOfTheWorld
Posts: 110
Joined: September 30th, 2008, 8:35 am

Timer options

March 26th, 2009, 7:04 am

Maybe interesting...
 
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tw
Posts: 1176
Joined: May 10th, 2002, 3:30 pm

Timer options

March 26th, 2009, 10:07 am

My question would be why buy such a thing?QuoteOriginally posted by: BLOBYAn article published 2 years ago ... but still relevant.My question is : HOW DO YOU HEDGE THAT PRODUCT (TIMER OPTION) ?? --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------"Societe Generale Corporate and Investment Banking (SG CIB) has developed a new type of option that allows buyers to specify the level of volatility used to price the instrument. Called a timer call, the product is designed to give investors more flexibility and ensure they do not overpay for an option.The price of a vanilla call option is determined by the level of implied volatility quoted in the market, as well as maturity and strike price. But the level of implied volatility is often higher than realised volatility, reflecting the uncertainty of future market direction. In simple terms, buyers of vanilla calls often overpay for their options. In fact, having analysed all stocks in the Euro Stoxx 50 index since 2000, SG CIB calculates that 80% of three-month calls that have matured in-the-money were overpriced."High implied volatility means call options are often overpriced. In the timer option, the investor only pays the real cost of the call and doesn't suffer from high implied volatility," says Stephane Mattatia, head of the hedge fund engineering team at SG CIB in Paris.Under the timer call, the buyer can specify an investment horizon and an expected volatility. A variance budget is then calculated (target volatility squared, multiplied by the target maturity), which forms the basis for the option's price. Once the variance budget is consumed, the option expires.For example, if an investor buys a timer call with a target of three months and believes volatility over this period will be 20, the variance budget would be 0.01 (0.2 x 0.2 x (91.25/365)). Once this is consumed - in other words, once realised volatility squared multiplied by the number of expired days divided by 365 is more than the variance budget - the option would expire.If the investor is correct and realised volatility is 20, the option will mature in exactly three months. If the realised volatility is lower than expected (say, 15), the option will expire at a later date (around five months). Likewise, if realised volatility is higher (say, 30), the option will expire sooner (around 1.3 months).SG CIB piloted the product with a small number of hedge fund clients in April, and is now rolling it out more widely to its client base. "The reception has been very positive, and we've already traded on stocks and indexes in Europe and the US, as well as on Asian indexes," says Alastair Beattie, managing director in the hedge fund group at SG CIB in London.The first trade was at the end of April with a hedge fund client. The fund unwound existing plain vanilla calls on HSBC with a June expiry and rolled them into an HSBC timer call. At the time, the implied volatility on the plain vanilla call was slightly above 15%, but the client set a target volatility level of 12%, a little higher than the prevailing realised volatility level of around 10%.By rolling into a timer call, the hedge fund reduced its premium by 20%. Since the inception of the trade, the realised volatility has been around 9.5%. If it remains at this level, the maturity of the timer call will be 60% longer than the original vanilla call. SG CIB has now traded on 20 underlyings for a total notional of EUR300 million."This product is going to have an application for anyone trading options where they find the implied volatility expensive," says Beattie. "The normal evolution for new products is that hedge funds will be first to move, then it will be picked up by other types of investors. Any sophisticated investor with a view on the volatility of an underlying as well as its price evolution, will be able to use it.""
 
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daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

Timer options

March 26th, 2009, 10:17 am

QuoteMy question would be why buy such a thing?Clearly, you are overthinking this and dont want to just enrich SG. Look at what Alastair saysQuote"This product is going to have an application for anyone trading options where they find the implied volatility expensive," says Beattie. "The normal evolution for new products is that hedge funds will be first to move, then it will be picked up by other types of investors. Any sophisticated investor with a view on the volatility of an underlying as well as its price evolution, will be able to use it."This is a no-brainer (for him that is) !muhahahaha
knowledge comes, wisdom lingers
 
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BLOBY
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Joined: May 17th, 2004, 5:07 am

Timer options

March 26th, 2009, 1:40 pm

tw, you would buy a timer call in order to be long equities, and without paying 50% the implied vol on 1 year for instance. This call 50% cheaper than a vanilla call.
 
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BLOBY
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Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 26th, 2009, 2:49 pm

EndOfTheWorld, your document is really very interesting.But do you know the difference between timer options and parisian options ?
 
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tw
Posts: 1176
Joined: May 10th, 2002, 3:30 pm

Timer options

March 26th, 2009, 4:07 pm

It's a short vol trade, right? If vol starts to realise at a high level, the maturity rapidly shrinks on your option?QuoteOriginally posted by: BLOBYtw, you would buy a timer call in order to be long equities, and without paying 50% the implied vol on 1 year for instance. This call 50% cheaper than a vanilla call.
 
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BLOBY
Topic Author
Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 26th, 2009, 4:31 pm

you're right tw
 
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BLOBY
Topic Author
Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 26th, 2009, 4:43 pm

Timer option pricing seems really similar to conditional variance swaps.But I often wondered how market makers could hedge conditional varswaps
 
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daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

Timer options

March 26th, 2009, 9:03 pm

I dont know if its short vol or you just have a fixed amount of variance to play with.
knowledge comes, wisdom lingers
 
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EndOfTheWorld
Posts: 110
Joined: September 30th, 2008, 8:35 am

Timer options

March 27th, 2009, 7:12 am

For the parisian options, the underlying needs to spend time in a certain range (exactly like the conditional variance swap), however to certain extents, high returns are irrelevant for this product (unlike the conditional of course…). For the timer options, it's all about realised vol and gamma/theta cost. On the other hand, with conditional VS, you are trading volatility and that's it.I think of the big problem with this product is that you can be absolutely right on your volatility view and still it does not pay (frustration…) vs. the vanilla. However, I'm sure they can be opportunity in selling call with high budget or using put when spot/vol correl attractive.
 
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BLOBY
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Posts: 113
Joined: May 17th, 2004, 5:07 am

Timer options

March 27th, 2009, 8:55 am

Excuse me EndOfTheWorld. could you explain more in details your last idea about selling call with high budget or using put when spot/vol correl attractive ?
 
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EndOfTheWorld
Posts: 110
Joined: September 30th, 2008, 8:35 am

Timer options

March 27th, 2009, 9:25 am

It was just a simple thought, but I did not find this product very attractive to buy. However, a classic screening on call overwriting candidates - chosing cheap vols and setting the vol target a couple of vols higher... SG would make the pricesRegarding the put (no market for that), it's just match perfectly the fact that the spot and vol are negtively correlated. If you hedge a portfolio with this you can maybe lower the cost of the hedge (with a low vol target), and when the underlying go down the realised increased, probably the convexity is you favour...
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