Tài chính doanh nghiệp - Chapter 16: Financial engineering and risk management

© 2004 South-Western Publishing1Chapter 16Financial Engineering and Risk Management2OutlineIntroduction and backgroundFinancial engineeringRisk management3Introduction and BackgroundFinancial engineering:Is a relatively new derivatives endeavorHas led directly to improvements in the process of risk management4Introduction and Background (cont’d)Risk management awareness is associated with various phrases:Asian fluGlobal contagionOrange County“We take the risks because of the potential reward”5Financial EngineeringSynthetic putEngineering an optionGamma risk6Synthetic PutFinancial engineering is the popular name for constructing asset portfolios that have precise technical characteristicsIn the early days of the CBOE there were no puts; only calls tradedCan construct a put by combining a short position in the underlying asset with a long call Synthetic puts were the first widespread use of financial engineering7Synthetic Put (cont’d) + = short stock + long call = long put8Engineering an OptionThere are a variety of tactics by which wealth can be protected without disturbing the underlying portfolioShorting futures provides downside protection but precludes gains from price appreciationWriting a call provides only limited downside protectionBuying a put may be the best alternative9Engineering an Option (cont’d)StrategyAdvantagesDisadvantagesShort futuresLow trading fees;Easy to doLose upside potential;Possible tracking errorWrite callsGenerate incomeLose most upside potential;Inconvenience if exercised;Limited protectionBuy putsReliable protectionPremium must be paid;Hedge may require periodic adjustment10Engineering an Option (cont’d)Extensive purchase of individual equity puts is inefficient in a large portfolioPortfolio may contain dozens of stocks, resulting in numerous trading fees, managerial time, and high premium costIndex options or futures options are best suited11Engineering an Option (cont’d)Financial Engineering Example Assume that T-bills yield 8% and market volatility is 15%. Black’s options pricing model predicts the theoretical variables for a 2-year XPS futures put option with a 325.00 striking price as follows: Striking price = 325.00 Index level = 326.00 Option premium = $23.15 Delta = -0.388 Theta = -0.011 Gamma = 0.016 Vega = 1.56612Engineering an Option (cont’d)Financial Engineering Example Linear programming models can be utilized to obtain the desired theoretical values from existing call and put options. The greater the range of striking prices and expirations from which to choose, the easier the task. 13Engineering an Option (cont’d)Financial Engineering Example Available XPSOptionsLinearProgrammingSynthetic PutWith DesiredTheoretical Values14Engineering an Option (cont’d)The tough part of engineering an option is dealing with the dynamic nature of the productTo keep the engineered put behaving like a “real” one, it is necessary to adjust the option positions that comprise it (dynamic hedging)How frequently you should reconstruct the portfolio to fine-tune delta depends on the rest of your market positions and the magnitude of the trading fees you pay15Engineering an Option (cont’d)Primes and ScoresPRIME is the acronym for “Prescribed Right to Income and Maximum Equity”SCORE stands for “Special Claim on Residual Equity”PRIMEs and SCOREs were arguable the first of the engineered hybrid securitiesSecurities provided investors a means of separating a stock’s income and capital appreciation potential16Engineering an Option (cont’d)Primes and Scores (cont’d) Americus TrustUnitPRIMESCORECommon Stock17Gamma RiskThere are several ways to engineer derivatives products that differ with regard to their cost and their robustnessGamma risk measures:How sensitive the position is to changes in the underlying asset priceThe consequences of a big price change18Gamma Risk (cont’d)An options portfolio with a gamma far from zero will rattle apart when the market experiences stormy weather19Gamma Risk (cont’d)Gamma Risk Example Suppose we hold 10,000 shares of a $60 stock and want to temporarily move to a position delta of zero. 20Gamma Risk (cont’d)Gamma Risk Example (cont’d)Options Data CallsPutsStrikePremiumDeltaGammaPremiumDeltaGamma50$11.240.8800.019$0.63-0.1210.01960$4.510.5650.037$3.84-0.4450.03870$1.310.2440.029$10.71-0.7870.03321Gamma Risk (cont’d)Gamma Risk Example (cont’d)Alternative Solution A PositionQuantityDeltaGammaPremiumStock+10,000+10,000--60 Call-100-5,650-370+$45,10060 Put+98-4,361+372-$37,632-11+2+$7,46822Gamma Risk (cont’d)Gamma Risk Example (cont’d)Alternative Solution B PositionQuantityDeltaGammaPremiumStock+10,000+10,000--50 Call-114-10,032-217+$128,136-32-217+$128,13623Gamma Risk (cont’d)Gamma Risk Example (cont’d)Both solutions have an initial position delta close to zeroSolution B has the attraction of bringing in a great deal more than Solution ASolution B’s negative gamma may be hurt by a fast marketAssume the underlying stock price rises by 5% to $6324Gamma Risk (cont’d)Gamma Risk Example (cont’d)Options Data CallsPutsStrikePremiumDeltaGammaPremiumDeltaGamma50$13.960.9270.012$0.36-0.0740.01360$6.380.6680.032$2.68-0.3390.03370$2.140.3360.033$8.47-0.6870.03525Gamma Risk (cont’d)Gamma Risk Example (cont’d)Alternative Solution A: 5% Increase in Stock Price PositionQuantityNew DeltaChange in Option ValueGain or LossStock+10,000+10,000-+$30,00060 Call-100-6,680+$1.87-$18,70060 Put+98-3,322-$1.16-$11,368-2+$6826Gamma Risk (cont’d)Gamma Risk Example (cont’d)Alternative Solution B: 5% Increase in Stock Price PositionQuantityNew DeltaChange in Option ValueGain or LossStock+10,000+10,000-+$30,00060 Call-114-10,568+$2.72-$31,008-568-$1,00827Gamma Risk (cont’d)Gamma Risk Example (cont’d)Solution A is preferable because:Its position delta remains near the target figure of zeroIts value changed by only $68, while the other portfolio declined by over $1,00028Risk ManagementManaging company riskManaging market risk29Managing Company RiskMany modern portfolio managers actively practice some form of delta managementDelta management refers to any investment practice that monitors position delta and seeks to maintain it within a certain rangeDelta is a direct measure of the “degree of bullishness” represented in a particular security position or portfolio30Managing Company Risk (cont’d) BullishOut of the FullyMarket 0% + + 100% Invested - - BearishPosition Delta31Managing Market RiskMost institutional use of SPX futures is to reduce risk rather than eliminate itIf you completely eliminate risk, returns should be modest 32Managing Market Risk (cont’d)Delta management of market risk involves futures puts and callsA long futures contract has a delta of 1.0Call options have deltas near 1.0 if they are deep-in-the-money and near zero if they are far out-of-the-money33Managing Market Risk (cont’d)Delta management of market risk involves futures puts and calls (cont’d)Puts have deltas near –1.0 when deep-in-the-money and near zero if far out-of-the-moneyWhen the striking price is near the price of the underlying asset, the option delta will be near 0.5 (for calls) or –0.5 (for puts)