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    Economics of Finance (U6022) Homework Assignment #2 Tracking A Hedged Options Portfolio Over Time Due: October 23, 2002

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    Veeken Chaglassian
    This homework assignment involves simulating a hedged options portfolio consisting of 100 long call options on 10-year Treasury futures and a daily adjusted futures hedge. Students are instructed to collect the closing option and futures prices each day from October 10 to 22, calculate the implied volatility, delta, and size of the futures hedge using Black-Scholes, and track the daily and cumulative profit/loss of the portfolio as the hedge is rebalanced daily to remain delta neutral.

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    Economics of Finance (U6022) Homework Assignment #2 Tracking A Hedged Options Portfolio Over Time Due: October 23, 2002

    Uploaded by

    Veeken Chaglassian
    57 views3 pages
    This homework assignment involves simulating a hedged options portfolio consisting of 100 long call options on 10-year Treasury futures and a daily adjusted futures hedge. Students are instructed to collect the closing option and futures prices each day from October 10 to 22, calculate the implied volatility, delta, and size of the futures hedge using Black-Scholes, and track the daily and cumulative profit/loss of the portfolio as the hedge is rebalanced daily to remain delta neutral.

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    Delta Hedging

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    This homework assignment involves simulating a hedged options portfolio consisting of 100 long call options on 10-year Treasury futures and a daily adjusted futures hedge. Students are instructed to collect the closing option and futures prices each day from October 10 to 22, calculate the implied volatility, delta, and size of the futures hedge using Black-Scholes, and track the daily and cumulative profit/loss of the portfolio as the hedge is rebalanced daily to remain delta neutral.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    57 views3 pages

    Economics of Finance (U6022) Homework Assignment #2 Tracking A Hedged Options Portfolio Over Time Due: October 23, 2002

    Uploaded by

    Veeken Chaglassian
    This homework assignment involves simulating a hedged options portfolio consisting of 100 long call options on 10-year Treasury futures and a daily adjusted futures hedge. Students are instructed to collect the closing option and futures prices each day from October 10 to 22, calculate the implied volatility, delta, and size of the futures hedge using Black-Scholes, and track the daily and cumulative profit/loss of the portfolio as the hedge is rebalanced daily to remain delta neutral.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    of 3

    Economics of Finance (U6022)

    Homework Assignment #2
    Tracking a Hedged Options Portfolio Over Time
    Due: October 23, 2002

    In this assignment, you will simulate a portfolio that consists of a long position in 100 T-
    note futures call options and hedged with futures. You will rebalance the hedge every
    day to stay delta-neutral.

    Underlying security: December 2002 10-Year T-Note Futures


    Strike: 115
    Expiration: November 22, 20021
    Option type: Call
    Exchange: Chicago Board of Trade

    Begin by collecting the call price and the futures price every business day. (The market
    is closed on Monday October 14 for the Columbus Day holiday.) You can find the prices
    in the New York Times or Wall Street Journal or the Chicago Board of Trade website.
    We will only work with closing or “settlement” prices.

    If you decide to use the CBOT website, go to www.cbot.com. Click on “Quotes and
    Data” then “Financial Futures” then “Ten Year Treasury Notes”. We want the Settle
    price for 02 Dec. If you want to do it all in one step, simply go to
    http://www.cbot.com/cbot/quotes/fin_futures/0,1860,TY+9,00.html . A price like
    “114260” means 114 + 26/32 = 114.8125. A price like “115225” means 115 + 22.5/32 =
    115.703125. Next you need the options price. Click on Financial Options and follow
    the links to 10 Year U.S. Treasury Note Calls for 02Dec. This will take you to
    http://www.cbot.com/cbot/quotes/fin_options/0,1851,TC+2002Z,00.html . You want the
    settle price for the 11500 strike. Options prices are quoted in points and 64ths. So 116
    means 1+16/64 = 1.25.

    Now you need to run the option through a Black-Scholes calculator. I would suggest:
    http://www.intrepid.com/~robertl/option-pricer3.html (If you find a better one, please let
    me know.)

    Here is an example for October 11, 2002. The text in bold is what you enter.

    Click the button for “volatility?”

    What is the option price? 1.25


    What is the stock price? 114.8125
    What is the dividend yield? 0
    What is the interest rate? 1.75
    How long left to expiration? 42 (i.e., the days between Oct 11 and Nov 22)

    1
    Technically, the options expire on Saturday November 23. But our analysis will assume that the option
    holder’s last exercise opportunity is Friday November 22, since the future market is closed on Saturdays.
    Click the buttons “Expiration in days”, “Call option” and “European option?”

    The program will automatically recalculate and you will see that

    Implied volatility = 7.90%


    Delta = .511
    Gamma =0.129
    Theta = -.017

    Let’s look at the analysis as of the previous day, Thursday October 10:

    What is the option price? 1.71875 (i.e., 1 +46/64)


    What is the stock price? 115.703125 (i.e., 115 + 22.5/32)
    What is the dividend yield? 0
    What is the interest rate? 1.75
    How long left to expiration? 43

    In this case,

    Implied volatility = 7.54%


    Delta = 0.628
    Gamma = 0.126
    Theta = -.0165.

    Imagine that you bought 100 calls at the closing price on Thursday October 10. You
    would have paid 1.25. Remember, the units are $100,000 and price is quoted in percent,
    so your cost per contract is 1.25 x 1000 = $1250. Since you are buying 100 calls, your
    total cost is 100 x $1250 = $125,000. To hedge, you have to sell futures. The amount
    you sell is delta x number of contracts = 0.628 x 100 = 62.8.2 On Friday, the T-note
    futures price fell sharply as the Dow Jones rallied by 316 points. After one day, your
    profit would be the sum of the loss on your calls and the profit on your hedge:

    Options profit 100 x (1.25-1.71875) x 1000 = -46,875.00


    Futures profit: 62.8 x (115.703125-114.8125) x 1000 = +55,931.25
    Net profit: $9,056.25

    Thus the portfolio earned a profit. You should not be surprised. Friday was a good day
    to be long options, because the market moved by a lot. You would have captured a big
    profit from your short hedge: the call delta dropped from 0.628 to 0.511, so you were
    “overhedged” during the market’s decline. Moreover, implied volatility rose from 7.54%
    to 7.90%, so the options became generally more valuable.

    2
    For the purposes of this assignment, we will assume you can buy or sell fractional contracts. In reality,
    this is not possible.

    2
    At the end of trading on Friday, October 11, you need to reduce the size of your hedge.
    According to the model, the delta has declined from 0.628 to 0.511. Thus you should buy
    back 100 x (0.628 – 0.511) = 11.7 contracts. In order to stay delta neutral, you should be
    short 51.1 futures contracts.

    Your assignment is to track the hedge every day through the close of business on
    Tuesday, October 22. Please create a table like this:

    Profit and Loss from 100 T-Note Calls, Hedge Rebalanced Daily
    Date 115 Calls Futures Delta Implied Hedge Options Total Cumulative
    Volatility P&L P&L Daily P&L P&L

    10-Oct-02 1.71875 115.703125 0.628 7.54


    11-Oct-02 1.25 114.812500 0.511 7.90 $55,931.25 $(46,875.00) $9,056.25 $9,056.25
    15-Oct-02
    16-Oct-02
    17-Oct-02
    18-Oct-02
    21-Oct-02
    22-Oct-02

    The Total Daily P&L is the sum of the change in your core call position plus the hedge
    P&L. The hedge P&L comes from your short futures position. You have to adjust the
    size of your futures position every day. The right-hand column is the sum of the daily
    P&L since you initiated this trade on October 10.

    This assignment will enhance your intuition on the Black-Scholes model and options
    pricing.

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