Hi there,I have an exotic equity structured product, but have no clue on how to decompose it into building blocks:Basically, it is a basket of a equity indices/stocks.At the maturity date, the payoff is equal to the WORST OF THE BASKET (indices or stocks).This is not too difficult, it is just an european correlation product.But the catch is that:There are a couple of observation dates before the expiration date. On EACH of these observation dates,if ALL THESE STOCKS LIE ABOVE THEIR INITIAL PRICE, the structure gets TERMINATED IMMEDIATELY (i.e. theEuropean Worst of basket payoff is no longer valid since the structure is knocked-out)From pricing point of view, I can lump everything together then able to get the price & greeks by brute-forcemethod (i.e Monte Carlo simulation) However, from trading desk point of view it is not sufficient. I am just wondering if anybody knows how to HEDGE THIS STRUCTURE. (i.e the appropriate building blocks)Many thanks, buddy !

Hey mates,It seems like that this product is an exotic version of NAPOLEAN option. I saw in another thread that this productwas discussed....Can anybody share with me how to decompose & hedge this kind of option ?Many thanks,

Complex Payout on a Complex Underlying.Good luck!

yes, extremely COMPLEX.any hint ??? if i have some idea to propose, my boss will be impressed (though no salary adjusment)

The Underlying.Worst Of:This is a big modelling problem in my view. Really big!It is fine in a simple world but there are significant cross greek terms - primarily - d(delta)/d(Vol) which most models do not take into account.In short your cash-future BASIS is highly volatility dependant.This is something that NOBODY prices in correctly.The PayoutI am not sure from your description what the payout actually is.A napolean on most equities is a guess as you have to make an adjustment/estimate for the effect of skew.

Why is it a BIG problem in worst of modeling ? i don't understand the following statements. can u explain further ?>>The Underlying.>>Worst Of:>>This is a big modelling problem in my view. Really big!>>It is fine in a simple world but there are significant cross greek terms - primarily - d(delta)/d(Vol) which most models >>do not take into account.>> short your cash-future BASIS is highly volatility dependant.>>This is something that NOBODY prices in correctly.Also SKEW BIG PROBLEM, how to cater ?>>A napolean on most equities is a guess as you have to make an adjustment/estimate for the effect of skew. OK, in brief i am based in an emerging market , not highly developed place (like NY, LONDON where there are always liquidity). When I do my Monte Carlo model for pricing Worst OF, I only assume everything very very simple:SDE with contant coefficientno volatiltiy smileno skew.What will be the effect if i missed out all these stuffs ? ANyway, in an emering market, does all these advanced quant stuffs can apply ? (e.g. stochastic vol model)ANother issue concerns the hedging:AT the end of the day, the model only gives me the delta, gamma .. with respect to the underlying STOCKS.But the trader won't be so stupid to hedge in thsi way, probably they hedge dynamically by THE OPTIONS instead.So the models are all useless ?? (unless i can get the delta with respect to the OPTIONS , ie. the no. of optiosn to buy/sell). Am I wrong ???Last question, I played with my model and found the following strange phenomeon:WORST-OF-PUT DECREASE WHEN CORR. INCREASES WORST-OF-PUT INCREASE WHEN CORR. DECREASES WORST-OF-CALL INCREASE WHEN CORR. INCREASES WORST-OF-CALL DECREASE WHEN CORR. DECREASES BEST-OF-PUT INCREASE WHEN CORR. INCREASES BEST-OF-PUT DECREASE WHEN CORR. DECREASES BEST-OF-CALL DECREASE WHEN CORR. INCREASES BEST-OF-CALL INCREASE WHEN CORR. DECREASES can anybody explain NON-MATHEMATICALLY WHY ????- I remembered UBS (Before merge) played a lot with these stuffs and finally got burned.what are the HIDDEN RISKS to the investors ??? Somebody said that as corr. increase, the vol. actually decreases (in risk magazine) I don't understand ???Thank you buddy.

I'm assuming money is talking about the best/worst performing asset in the basket, in which case:non-mathematically (and very simplistically):best-of call - we want the assets to disperse( low correlation), so that the best performing performs really wellworst of call - if the assets disperse, the worst performing is bound to be rubbish. If they are correlated, the worst performing will either be rubbish or good which is a better propositionbest of put - if the assets disperse, the best performing asset will likely perform well, which given we have a put on it is bad. We want them to be correlated so it is either good or bad rather than definitely bad.worst of put - we want the assets to disperse, so that the worst performing is really bad.

money,it sounds to me like you are a complete beginner in exotics.You rightly say that ubs, and many others, blew hundreds of millions on correlation and its skew.My advice would be to buy the product from a wholesaler bank (ask prices from as many as possible), and pass it on to your investors. Don't keep any risk on your book that you do not understand.By the way you ask what are the hidden risk to investors. that is the easier thing: investors do not hedge, and they normally hold it to maturity,so forget volaility and correlation and just do worst case scenarios.

are u an exotics trader ???how do one trade the best/worst of basket ?with the model, i only get the delta, greeks and cross-gamma... etc.but in reality it seems like they trade by hedging with PLAIN-VANILLA OPTIONS dynamically.how to get the adjusted greek (i.e. the no. of options to buy/sell rather than underlying assets)also how come in trading desk, their definition of vega is different from that taught at school ???they use percentgae scale ...

why are you trying to price this product that you do not understand? do you want to invest in it without hedging? then do scenario analysis and forget technicalitiesdo you want to sell it to your customers and have as little risk as possible? then buy it wholesale from somebody else. have you been asked to risk manage it? admit to your boss that you do not know how to do it.there is nothing wrong in not knowing exotics. but you could do a lot of damage by trading/ pricing/ risk managing this stuff if you do not even know how to work out the correlation exposure of best-of forwards on the back of an envelope.

it seems like i made a mistake... i checked that the product i described is NOT Napolean option but rathersth. called "Coupon Comet Snowball"is there any simple building block for this structure ???? since the whole structure is contingent on KNOCK-OUT condition, my guess is to use American option to hedge ... anybody has opinion ?

it seems like i made a mistake... i checked that the product i described is NOT Napolean option but rathersth. called "Coupon Comet Snowball"is there any simple building block for this structure ???? since the whole structure is contingent on KNOCK-OUT condition, my guess is to use American option to hedge ... anybody has opinion ?