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EdisonCruise
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Posts: 117
Joined: September 15th, 2012, 4:22 am

Is there any industrial standard method to hedge option while need to roll future?

January 14th, 2016, 2:50 am

Suppose I sell a call option expiring on September on March. Active future contracts are on June and October. So I need to long June contract since March, then near the end of May, I need to switch to October contract. Usually at the end of May, October contract is 1-2% higher than the June contract. Is there any industrial standard way to reduce the loss due to switching contract?Thank you.
 
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daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

Is there any industrial standard method to hedge option while need to roll future?

January 14th, 2016, 8:06 am

you have to price the carry into the option
knowledge comes, wisdom lingers
 
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EdisonCruise
Topic Author
Posts: 117
Joined: September 15th, 2012, 4:22 am

Is there any industrial standard method to hedge option while need to roll future?

January 15th, 2016, 8:30 am

Thank you daveangel.I think that this can be cured by pricing with carrying cost theoretically. However, it seems that there is still an accounting issue. Say, we have sold a call option expiring on Sep and hedging it with June future. Suppose we hedged the option perfectly until May. On someday of May, we want to switch from June future (today the price is F1, last day is F1_) to Dec future (price F2).Before switching from June future:Option price: C(F1)Money account: option premium + hedging PnLFuture account: F1*delta1Up to now C(F1) = option premium + hedging PnLAfter switching to Dec future :Option price: C(F2)Money account: option premium + hedging PnL + (F1-F1_)*delta1Future account: F2*delta2If F2 is usually higher than F1, C(F2) will be higher than C(F1). It is possible that C(F2) > option premium + hedging PnL + (F1-F1_)*delta1. So after switching, the hedging profit and option price can no longer match to each other. This will become a problem when report to risk manager.As I know, some traders cure this by catching the opportunity when F1 and F2 gets close. But what if F1 and F2 cannot be close enough?
 
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daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

Is there any industrial standard method to hedge option while need to roll future?

January 15th, 2016, 3:17 pm

how is the october option settled ? Is it cash based on some spot rate or is there delivery of the dec future ?
knowledge comes, wisdom lingers
 
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EdisonCruise
Topic Author
Posts: 117
Joined: September 15th, 2012, 4:22 am

Is there any industrial standard method to hedge option while need to roll future?

January 18th, 2016, 12:00 am

The option is settled by cash, depending on the spot rate of dec future, say on its price of 15th , Sep.
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