Option Strategist Exercise 3: exploring volatility spreads
In this exercise we will examine the effects of changes in market variables on a variety of volatility spreads. This will also give you practice in setting up positions which involve more than one option.
Underlying: GBP/USD
Price quoted in USD
Contract size: £1,000
European Option
Options on cash
One tick = 1/10,000 of quoted price
Value of one tick = 0.1 USD
USD Year basis = 360 days
GBP Year basis = 365 days
For all of the following positions use 1000 contracts (£1,000,000) per leg of the spread
• Buy a call ratio backspread (ratio 2:1) with 1.69 and 1.75 strike 30 day options.
Cable spot rate 1.69
Volatility 20%
US Interest Rates 5%
UK Interest Rates 5%
• What view of the market is the trader taking and what position is the seller of this spread taking?
• What are the delta and vega exposures in % and £?
c) For the following levels of spot write down the delta exposure and the P&L. Explain what you observe.
Spot
Delta exposure
P&L
1.71
1.75
1.78
1.60
1.63
1.69
• For the following spot rates and days elapsed, write down the P&L of the backspread. Where is time decay greatest?:
5 days
10 days
15 days
20 days
29 days
1.69
1.75
1.80
1.65
1.60
• What happens to the positions P&L as you increase the implied volatility? At what spot rate is the position most sensitive to changes in implied volatility? Why is this the case?
• Set both the initial spot and current spot to 1.75 and buy a put ratio backspread (ratio 2:1) with 1.69 and 1.75 strike 30 day options. What view of the market is the trader taking (and the seller)?
• What are the delta and vega exposures in % and £?
b) For the following levels of spot write down the delta exposure and the P&L. Explain what you observe.
Spot
Delta exposure
P&L
1.71
1.75
1.78
1.60
1.63
1.69
• For the following spot rates and days elapsed, write down the P&L of the backspread. Where is time decay greatest?:
5 days
10 days
15 days
20 days
29 days
1.69
1.75
1.80
1.65
1.60
• What happens to the positions P&L as you increase the implied volatility? At what spot rate is the position most sensitive to changes in implied volatility? Why is this the case?
• Set both the initial spot and current spot to 1.75 and buy a call ratio vertical spread (ratio 2:1) with 1.69 and 1.75 strike 30 day options. What view of the market is the trader taking?
• What are the delta and vega exposures in % and £?
b) For the following levels of spot write down the delta exposure and the P&L. Explain what you observe.
Spot
Delta exposure
P&L
1.71
1.75
1.78
1.60
1.63
1.69
c) For the following spot rates and days elapsed, write down the P&L of the vertical spread. Where is time decay greatest?:
5 days
10 days
15 days
20 days
29 days
1.69
1.75
1.80
1.65
1.60
d) What happens to the positions P&L as you increase the implied volatility? At what spot rate is the position most sensitive to changes in implied volatility? Why is this the case?
• Set both the initial spot and current spot to 1.69 and buy a put ratio vertical spread (ratio 2:1) with 1.69 and 1.75 strike 30 day options. What view of the market is the trader taking?
• What are the delta and vega exposures in % and £?
b) For the following levels of spot write down the delta exposure and the P&L. Explain what you observe.
Spot
Delta exposure
P&L
1.71
1.75
1.78
1.60
1.63
1.69
c) For the following spot rates and days elapsed, write down the P&L of the vertical spread. Where is time decay greatest?:
5 days
10 days
15 days
20 days
29 days
1.69
1.75
1.80
1.65
1.60
• What happens to the positions P&L as you increase the implied volatility? At what spot rate is the position most sensitive to changes in implied volatility? Why is this the case?
• Set the spot rates back to 1.71. Set up a long butterfly spread using 30 day calls with 1.69, 1.71 and 1.73 strikes. What do you notice about the greek exposures and what market conditions would maximise P&L on this position?
• Set the spot rates back to 1.71. Set up a short butterfly spread using 30 day calls with 1.69, 1.71 and 1.73 strikes. What do you notice about the greek exposures and what market conditions would maximise P&L on this position?
7. Set the spot rates back to 1.69. Set up a long time spread with 3 month and 6 month options both with 1.69 strikes. What do you notice about the theta and vega exposures? Why is this the case?
• Increase the “days elapsed” in increments of 20 days. Why is the P&L Positive?
•
• Increase the implied volatility in increments of 5%. Why is the P&L still positive?
c) Where do the biggest losses occur and why (look at the current P&L diagram)?