RISK MANAGEMENT

5st Assignments
GROUP 4

Lecturer: Dr. Ika Pratiwi Simbolon

Created By:

1. Daniel Ronaldo Nainggolan (008201500111)

2. Detty Cindy Putri (008201500045)
3. Laxmi KusumaWardhani (008201500014)
4. Ni Putu Devi Elvira Lestari (008201500023)
5. Putri Winahyu (008201500125)
Faculty/Major/Class : Business/Accounting/Taxation 2015

President University
Jababeka Education Park

Jalan Ki HajarDewantara, Kota Jababeka-CikarangBaru 17550

Website: www.president.ac.id-Email:enrollment@president.ac.id
1. The Vega of a derivatives portfolio dependent on the dollar-sterling exchange rate is 200 ($
per %). Estimate the effect on the portfolio of an increase in the volatility of the exchange
rate from 12% to 14%.
Answer: Vega of the portfolio is $200 per % change in exchange rate. As the exchange rate
is increasing by 2% (12% become 14%), the derivative portfolio price will increase by 2 X
$200 =$ 400.

2. The gamma of a delta-neutral portfolio is 30 (per $). Estimate what happens to the value of
the portfolio when the price of the underlying asset (a) suddenly increases by $2 and (b)
suddenly decreases by $2.
Answer: Gamma is a second order derivative so its impact will be:
(𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆)𝟐
Gamma X 𝟐
30(2)2 30(−2)2
So: (a) = 60 increase (b) = 60 increase
2 2

3. What does it mean to assert that the theta of an option position is –100 per day? If a trader
feels that neither a stock price nor its implied volatility will change, what type of option
position is appropriate?
Answer: A theta of -100 that if t units of time pass with no change in either the stock price or
its volatility, the value of the option declines by 100 t. A trader who feels that neither the
stock price nor its implied volatility will change should write an option with as high a
negative theta as possible. Relatively short-life at-the-money options have the most negative
thetas.

4. What is meant by the gamma of an option position? What are the risks in the situation where
the gamma of a position is large and negative and the delta is zero?
Answer: The gamma of an option position is the rate of change of the delta of the position
with respect to the asset price. For example, a gamma of 0.1 would indicate that when the
asset price increases by a certain small amount delta increases by 0.1 of this amount. When
the gamma of an option writer’s position is large and negative and the delta is zero, the
option writer will lose significant amounts of money if there is a large movement (either an
increase or a decrease) in the asset price.
5. “The procedure for creating an option position synthetically is the reverse of the procedure
for hedging the option position.” Explain this statement.
Answer: To hedge an option position, it is necessary to create the opposite option position
synthetically. For example, to hedge a long position in a put, it is necessary to create a short
position in a put synthetically. It follows that the procedure for creating an option position
synthetically is the reverse of the procedure for hedging the option position.

6. Why is an Asian option easier to hedge than a regular option?

Answer: Asian options are options where price of the underlying variable is regarded as the
average price over a certain period of time. This is the reason that the Asian options have a
lower volatility and so rendering them economical relative to their European counterparts.
These are basically traded on commodity products and currencies that have low trading
volumes. Asian options are easier to hedge than regular options as the payoff from an Asian
option becomes more certain with the passage of time. As a result, the amount of uncertainty
that needs to be hedged decreases with the passage of time.

7. Explain why there are economies of scale in hedging options.

Answer: Economic of scale are factors that caused the average cost of producing something
to fall as the volume of its output increases. In case of hedging the option, an investor will
electing the appropriate combinations of strike price, expiration date and type of option that
can minimize risk and maximize the probability of making a profit. To selecting the option,
economic of scales is considered important for investors by increasing their profits by
making the hedging option more efficient, rather than by increasing the price of the options
with a cost-effective way. And because hedging method is being used by the investor to
reducing the risk, it’s important for investor to consider about the economic of scale since it
will be reducing the cost of options (cost-effective way) and will help the investor to
minimize the risk.

8. The gamma and vega of a delta-neutral portfolio are 50 per $ and 25 per %, respectively.
Estimate what happens to the value of the portfolio when there is a shock to the market
causing the underlying asset price to decrease by $3 and its volatility to increase by 4%.
 Answer: With the notation of the text, the increase in the value of the portfolio is
0.5 x gamma x (ΔS)2 + Vega x Δσ
So, 0.5 × 50 × 32 + 25 × 4 = 325
The result should be an increase in the value of the portfolio of $325.

9. A financial institution has the following portfolio of over-the-counter options on sterling:

A traded option is available with a delta of 0.6, a gamma of 1.5, and a vega of 0.8.
(a) What position in the traded option and in sterling would make the portfolio both gamma
neutral and delta neutral?
(b) What position in the traded option and in sterling would make the portfolio both vega
neutral and delta neutral?
Answer: Requires traded option for a delta of 0.6, a gamma of 1.5, and a vega of 0.8.
The Delta of the portfolio:
﴾(-1,000 x 0.50) + (-500 x 0.80) + (-2,000 x -0.40) + (-500 x 0.70) ﴿= -450
The Gamma of the portfolio:
﴾(-1,000 x 2.2) + (-500 x 0.6) + (-2,000 x 1.3) + (-500 x 1.8)﴿ = -6,000
The Vega of the portfolio:
﴾(-1,000 x 1.8) + (-500 x 0.2) + (-2,000 x 0.7) + (-500 x 1.4)﴿ = -4,000
a. A long position in 4,000 traded options will give a Gamma-neutral portfolio.
6000/1.5 = 4000
(-6000 + (1.5 x 4000)) = 0
The Delta of the whole portfolio (including traded options) is then:
4 000  06  450  1 950
 Hence, in addition to the 4,000 traded options, a short position of 1,950 in sterling is
necessary so that the portfolio is both Gamma and Delta neutral.
b. A long position in 5,000 traded options will give a Vega-neutral portfolio.
4000/0.8 = 5000
(-4000 + (0.8 x 5000)) = 0
The Delta of the whole portfolio (including traded options) is then:
5 000  06  450  2 550
Hence, in addition to the 5,000 traded options, a short position of 2,550 in sterling is
necessary so that the portfolio is both Vega and Delta neutral.

10. Consider again the situation in Problem 7.17. Suppose that a second traded option with a
delta of 0.1, a gamma of 0.5, and a vega of 0.6 is available. How could the portfolio be made
delta, gamma, and vega neutral?
Answer: Let assume w1 is the first traded option and w2 is the second traded option. We
require:
6 000  15w1  05w2

4 000  08w1  06w2

6 000  15w1  05w2 X 6 36,000 = 9 w1 + 3 w2

4 000  08w1  06w2 X 5 20,000 = 4 w1 + 3 w2

16,000 = 5 w1

w1 = 3,200

6 000  15w1  05w2  6,000 = (1.5 x 3,200) + 0.5 w2

w2 = 2,400

The whole portfolio then has a delta of

450  3 200  06  2 400  01  1 710
Therefore, the portfolio can be made Delta, Gamma and Vega neutral by taking a long
position in 3,200 of the first traded option, a long position in 2,400 of the second traded
option and a short position of 1,710 in sterling.
 References
http://www.investopedia.com/terms/a/asianoption.asp

http://www.optiontradingpedia.com/synthetic_positions.htm

http://www.investopedia.com/walkthrough/corporate-finance/5/risk-management/hedging-
options.aspx

http://www.economist.com/node/12446567