Monday, November 10, 2008

Managing an Option Portfolio around and Economic Events or Cooperate Action Dates

In the advent of Economic Events and Cooperate Action the following can happen:
• Implied volatility can increase leading up to the event and subsequently fall after directional move
• Implied volatility can increase leading up to the event and subsequently increase with the historic volatility also increasing

Depending on the event an option portfolio need to hedged as follows

If the even would result in the option volatility rising up to the then the following need to be checked:
• Is the volatility surface skewed towards the back months, in which case the option’s implied time to expiration should be compared using the forward options implied volatility and by fudging the time to expiration, if the fudged time to expirations are some what than they actually are, this can be used as a candidate for a diagonal spread
• Whether the event would be directional or would create uncertainty

If the event would create uncertainty the ideal position would be to make the portion of options (equity option if it is a cooperate event, equity and index related option if it is an economic event) which would be effected by such event Vega neutral but Volga positive, while being delta neutral. This can be done by going diagonally.

If the uncertainly reduces after the day with a possible large change in asset value, the ideal would be negative Vega.

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