Options Training Week

Attend this training week programme and save over 15% on the combined price of: Options: Trading & Risk Management (Days 1-3) Exotic Options (Days 4-5) This 5-day agenda is structured to provide delegates with a comprehensive understanding of all aspects of financial options – from their basic mechanics and operational characteristics, detailed analysis of price modelling and risk characteristics, to their uses and applications in a wide variety of contexts – in hedging, trading and investment strategies. The first 3 days focus on building a progressive understanding of these topics for vanilla options; whilst the final 2 days extend the scope to a similar analysis of exotic options and structured products, as well as returning to examine more advanced issues in the pricing and risk management of options, particularly relevant for more complex option payoffs, which present a number of unique challenges in their valuation and risk characteristics. Whilst rigorous in its treatment of the more quantitative aspects of options, the main focus of the programme is to provide delegates with a thorough and practical understanding of the properties of options, how and why they are used in a wide variety of different contexts, an intuitive understanding of the concepts in option valuation, and the role of more advanced pricing techniques in addressing some of the weaknesses of simple ‘market’ models. The programme also seeks to provide an understanding from both an end user’s perspective as well as that of an option trader or market maker. All strategies are examined from the perspective of how they are applied to risk management or trading strategies, as well as analysed in respect of the risk management implications for an option market maker. The programme agenda uses a wide variety of computer based (Excel™ based) simulations and exercises, to gain practical exposure to key principles and concepts, and to facilitate understanding of the key course objectives – option pricing models, dynamic management of option risk exposures, designing and implementing trading and risk management strategies using vanilla and exotic options, and design and structuring of (option embedded) structured products. Constructing and calibrating option pricing models Designing option based hedging strategies Understanding option risks and dynamic risk management Applying vanilla and exotic options in designing structured products Practical applications of first and second generation exotic options Advanced option valuation models and techniques Designing and tailoring option strategies to exploit market expectations Directional, volatility and correlation trading strategies Yield enhancement strategies using options
Part 1: Options: Trading & Risk Management Option Valuation – Principles and Option Pricing Models Fundamental concepts and properties of options - Key terminology - Put-Call parity Intuitive understanding of option pricing principles and price determinants - Intrinsic value and time value - European styles Versus American style options Continuous stochastic processes; Brownian motion Analytical models: The Black-Scholes option pricing framework Underlying concepts, assumptions and derivation of the Black-Scholes pricing model Advantages and shortcomings of the Black-Scholes framework Rationalising distortions to the Black-Scholes model framework - Discontinuous market behaviour - Stochastic Volatility - Imperfections in modeling assumptions Numerical methods: Binomial and trinomial lattice models Arbitrage-free derivation of a generalised binomial model Valuing American and other path dependent options Simulation methods of option valuation – Monte Carlo simulation Case Study: Building option pricing models; valuation of European, American option styles Volatility Understanding volatility; the role of volatility in option pricing Volatility as an ‘asset class’ Historic, implied and realised volatility measures Volatility surfaces - Volatility smiles and skews - Volatility term structure effects Rationalising and interpreting volatility surfaces - Skewness and Kurtosis - Vanna-Volga approach to constructing volatility surfaces Volatility analysis - Volatility relative value analysis (Implied Vs. realized) - Volatility cones - Skew interpretation and analysis Local Volatility models Stochastic volatility modeling - Heston stochastic volatility model Option Risks; Hedging and Risk Management of Option Positions First order price risks: Delta, vega, theta, rho, phi Delta hedging and risk analysis - Dynamic delta risk management - Delta hedging an option portfolio - Limitations and risks inherent in delta hedging - PIN risk - Expiration effects - Liquidity effects Gamma - Interpreting gamma - Gamma characteristics of in-, at- and out-of-the-money options - Long and Short Gamma – risks and opportunity - Impact of Gamma on Delta hedge management - Implied Vs. realized volatility exposure - ‘Shadow’ Gamma - Maximising profitability from Gamma trading and management; Gamma ‘scalping’ Vega - Implied volatility risk - Vega characteristics - Smile and skew risks: Sega and Rega Theta; option price time decay - Theta as cost of carry - Inter-relationship between Theta, Gamma Rho; Interest rate sensitivity Understanding and actively managing interrelationships between option price sensitivities Active management of portfolio delta, gamma and vega risks Other higher order risks - Delta time decay (Charm) - Gamma sensitivity (Speed, Colour) - Vanna and Volga risks - Management of higher order risks - Risk reversals in management of skew (Vanna) risk - Butterflies in management of smile (Volga) risk Limitations of option ‘Greeks’ - Discontinuities in market price behaviour, option risks - Expiration trading - Strategies for managing risk when ‘Greeks’ experience large, discrete changes - Stress testing and portfolio scenario analysis; identifying potential future risks Case Study: Dynamic management of option risks in a single option position/portfolio context; Delta hedging and the analysis of trading p/l over a trading horizon. Exercise will involve managing position Gamma in order to attempt to maximise profitability. Option Strategies – Hedging and Risk Management Risk reduction strategies with options Using options in corporate FX, rates and commodity risk exposure management Option based hedging strategies in portfolio management - Simple hedging strategies - Vanilla Call/Put hedges - Tailoring client objectives and constraints using strike variation - Costs and benefits of options versus outright forward hedges Structuring tailored hedges with options - Zero cost Collars/Cylinders and Range Forwards - Option spreads and Participating Forwards - Seagulls - Extendible flat forwards Tailoring structures to meet client expectations, objectives and constraints: - Strike selection - ‘Pain thresholds’ – minimum/maximum strike levels - Budget constraints: zero cost strategies - Impact of market factors (swap points, volatility surfaces) on economics of strategies - Incorporating covered option sales into hedging strategies Rationale for using non-linear (options) Vs. linear hedges - When is it rational to use options for hedging? - Comparative analysis of risk management strategies - Advantages/shortcomings of risk management solutions: cost/benefit analysis - Tailoring strategies to client risk management policy, constraints and expectations - Using options in hedging contingent risks Case Study: Delegates will conceive, structure and price a range of vanilla and structured option based hedging strategies to meet varying objectives and constraints. Delegates will be presented with a range of different ‘client’ circumstances and background information (market data, financial reporting data, and additional anecdotal client information) and will be responsible for analysis and evaluation, preparation and pricing of a number of proposed alternative hedging strategies. Option Strategies – Trading, Investment and Arbitrage Strategies Overview of trading applications of options - Directional trading - Volatility trading - Distinguishing Vega from Gamma trading strategies - Higher order volatility trading strategies - Convexity trading - Dispersion trading - Arbitrage strategies - Limited Vs. unlimited risk strategies - Premium generation (yield enhancement) strategies Put-Call parity and arbitrage strategies - Conversions and Reversals - Synthetic forwards - Box spreads Directional Trading: Vertical Spreads - Call and put (Bull and Bear) spreads - Trading Rationale - Pricing; impact of skew - Risk characteristics - Delta hedging - Gamma - Skew risk Volatility trading strategies Calendar Spreads - Rationale - Volatility term structure (calendar skew) impact - Sensitivities; volatility/time decay exposure Straddles and Strangles - Structure and rationale - Risk characteristics - Vega and Gamma trading - Skew and smile effects - Dynamic risk management Risk reversals - Skew trading using risk reversals - Using risk reversals to manage Vanna (Skew) risk Butterflies - Volatility trading with Butterflies - Using Vega neutral butterflies to manage and trade Smile risk - Management of Volga risk Yield enhancement strategies - Over and under-writing strategies - Rationale for covered call/put strategies - What are the risks in premium generation strategies? - What is an optimal tenor/strike for yield enhancement strategies? Dispersion trading - Correlation trading - Monetising implied Vs. realised correlation - Practical challenges in dispersion trading - Rationale for dispersion trading Embedded Option Strategies Embedding options into structured products Long and short volatility structured products Yield enhancement structured products - Callable bonds and notes - Reverse convertibles - Inverse FRNs Capital guaranteed notes Interest Rate Options Generic European style interest rate caps and floors Conventional pricing methods: Black (1976) model Why do markets use this model? Advantages and disadvantages Calibration to a volatility surface Pricing and hedging caps and floors - Stochastic term structure models (BDT, LIBOR market model) - SABR model Risk management - Delta hedging caps and floors - Gamma and Vega management; risk bucketing Practical applications - Asset and liability risk management - Embedded caps and floors; capped FRNs, Minimax FRNs - Reverse FRNs Swaptions - Pricing swaptions: Black Vs. Term structure models - European and Bermudan style swap options - Calibration of swaption volatility surfaces - Compatability and consistency with Cap pricing - Option Embedded Swaps - Extendible and cancellable swaps (European, Bermudan styles) FX Options Fundamental properties of Currency Options Market conventions, terminology, price quotation Pricing Vanilla FX Options – Garman-Kohlhagen model Building volatility surfaces for FX options: Risk Reversals and Butterflies Applications of Vanilla FX options in Currency Risk Exposure Management Risk reduction (Hedging) strategies with options Using options in corporate FX risk exposure management Rolling and layered hedging programmes Simple hedging strategies - Vanilla Call/Put hedges - Tailoring client objectives and constraints using strike variation - Costs and benefits of options versus outright forward hedges Structuring tailored hedges with options - Zero cost Collars/Cylinders and Range Forwards - Option spreads and Participating Forwards - Seagulls Tailoring structures to meet client expectations, objectives and constraints: - Strike selection - ‘Pain thresholds’ – minimum/maximum strike levels - Budget constraints: zero cost strategies - Impact of market factors (swap points, volatility surfaces) on economics of strategies - Incorporating covered option sales into hedging strategies: finding client target or ‘indifference’ levels Rationale for using non-linear (options) Vs. linear hedges - When is it rational to use options for hedging? - Comparative analysis of risk management strategies - Advantages/shortcomings of risk management solutions: cost/benefit analysis - Tailoring strategies to client risk management policy, constraints and expectations - Using options in hedging contingent risks Equity Options European and American styles Single stock and index options Incorporating dividend assumptions into pricing models Correlation dependency of basket and index options Analysing relative value of index options: Implied vs. realised correlation patterns Part 2: Exotic Options The Mechanics of Exotic Options Exotic option classification Pay-off structure Path dependency (strong and weak) Exercise timing Order Decision dependency Multivariate dependencies Motivations and applications of exotic options Vanilla options and their limitations Customised and complex pay-off structures Flexibility Risk management applications; managing corporate exposures Cost comparison (Exotics versus vanilla alternatives) When are simple or exotic option strategies optimal? Pricing and Risking Exotic Options Practical problems in modelling exotic option pay-offs Path dependency Skew risk and pricing effects Model calibration: How to adjust for smile and skew effects Vanna-Volga approach to constructing volatility surfaces Local volatility models (Dupire et al.) Advantages and shortcomings Stochastic volatility (SV) modelling Combining Local and Stochastic volatility modelling Exotic option risk characteristics - Hedging higher order moments of risk - Skew sensitivity in exotics - Discontinuous risk behaviour; limitations of using ‘Greeks’ in hedging Barrier Options Overview of types (knock-ins and knock-outs; single and double barriers) Pricing and valuation of Barrier options - Numerical (tree) methods of Barrier option pricing - Pricing double barrier options and other variants - Impact of varying barrier parameters on performance, cost - Pricing using volatility surface Hedging Barrier options Risk sensitivities and their characteristics OTM Barriers - Replication/Hedging - Change in Greeks through Time ITM Barriers - Replication/Arbitrage bounds - Change in Greeks through Time Higher order sensitivities Applications of Barrier Options - Trading and hedging applications - Rationale for barrier options – when to use and when not to use barrier options Structured barrier option strategies - Barrier structures (Forward plus) - Knock-in Cylinders - Knock-out Forwards - Knock-out Collars Applications of barrier options in structured notes - Equity Bonus notes and certificates - Twin-win certificates - Reverse convertibles Case study: Constructing and pricing Barrier option structured hedging strategies; Structured product embedded barrier options Digital (Binary) Options European and American ‘one touch’ styles Contingent Premium Options Pricing of digital options Adapting the Black-Scholes analytical approach Hedging and risk management of digital options Dynamic Delta hedging - limitations Gamma, Vega, Theta behaviour Higher order moments of risk; skew risk Replication using risk reversals Inadequacies of Black-Scholes theory in practice Applications of digital options: Trading apns – motivations for using digital options Contingent premium options ‘Range accrual’ structured notes; range accrual swaps Digital caps and floors Term sheet examples (interest rate, FX, hybrid examples) Path Dependent Options - Average Rate Options AROs (Average Rate Options) and ASOs (Average Strike Options) Mechanics of average rate options Geometric vs. Arithmetic averages Pricing of the Asian options - Continuous averaging and discrete averaging - Partial averaging: weighted and un-weighted samples - Analytical models - Numerical solutions Hedging Asian options - Risk sensitivities - Dynamic replication using Vanilla options Practical Applications of Asian Options Hedging corporate exposures with Asian options - Practical examples of the motivations and rationale for the use of Asian options - Asian Tails; Embedded Asian options – e.g. Structured equity linked bonds Case study: Pricing Asian Options; structured product applications Path Dependent Options - Lookback, Cliquet and Reverse Cliquet Options Definitions Pay-off types - Fixed and floating strike - Discrete and continuous sampling of maximum/minimum Pricing and valuation issues - Numerical (tree) methods Motivations for use – applications and examples Multi-asset Options Basket options Spread options Outperformance, ‘Best of’’ and ‘Worst of’ option styles Pricing methodologies Single factor and multi-factor approaches Impact of basket parameters (volatility, correlation) on pricing Where can we find correlation data from? Sources of implied correlation Hedging and risk management of multi-asset options Where can we find correlation data from? Sources of implied correlation Risks characteristics Cross Gamma – correlation risk Dynamic management of correlation risk Uses and applications of multi-asset options Basket options Hedging and trading spread risk Minimising cost and maximising yield enhancement with multi-asset options Structured product applications: - CMS Spread linked notes - ‘Best of’ and ‘Worst of’ structured products - Altiplanos - Multi reverse convertibles - Hybrid structured products Quanto Options Pricing quanto options Replication approach Analytical approach Pricing parameters – correlation and volatility inputs Hedging quanto derivatives Correlation and volatility risks Dynamic correlation risk management Applications of Quanto options Hedging FX translation exposure Foreign Equity/Domestic Currency Options Structured notes with quantoed pay-offs Embedded Exotic Options - Structured Products Rationale for issuers and investors Yield enhancement Capital protection Tailored investment strategies Financial engineering; creating and analysing structured debt Interest rate linked structured products Callable/Puttable bonds Range accrual structures Exotic path dependent structured notes (LIFTs, Snowballs etc.) TARNS and other path dependent structures Equity linked structures Bonus certificates Multi-asset structures Reverse convertibles Hybrids FX structured products Forward plus, knock out forwards, knock in cylinders PRDCs Range accrual structures Case study: Delegates will have the opportunity to reverse engineer a number of examples of structured products as well as creating and pricing a range of structured product types, across all main asset classes. Course summary and close