Option Pricing And Risk Management

What is the mechanism of options in finance, how the theory is coping with market reality, with Excel practice.

What you'll learn

Learn the principle of Option Pricing

Extensive review of the Black Scholes Model and its Greeks

How to manage an option Portfolio

Refresher of usefull Mathematical Conepts: derivatives and Taylor Development

Practical exercises of gamma hedging and pricing

The Volatility Smile

Build an Option Risk Management System in Excel

Requirements

Knowledge of basic Math functions: Exp, Ln

Description

Pricing and risk are deeply intricated and this allows to manage a portfolio of options.This class was originally created for IT developer with no finance knowledge who were going to work in a Bank or a Hedge Fund.It can be also useful for people getting into the banking industry.This class is NOT about how to make easy money without risk by trading options. Remember, in Finance, there is No Free Lunch.The Normal Law will be studied in details, as it is the building block of the Black Scholes model and it is extensively used in Finance.Detailed description of Option. Why do we need an option model, can we see an option with a static hedge: the notion of break-evenAnother 'must know' is the Taylor Development and the mathematical Derivative, a chapter that will allow the student to learn or review these concepts.The Black Scholes model and its Greeks will be analysed in detail, especially its replication theory: you will have an assessment to risk manage a dummy option portfolio until its maturity in Excel, this is a good way to understand how the Gamma/ Theta works. Back in the days when I was a trader, the seasoned option traders used to say "you do not understand Gamma nor Theta until you lose 50K $ on it".So this live Simulation is in my opinion a very good exercise, and it saves 50K $ ;-)The Vega risk management: we will prove that it is nice to be long Out of the Money options, this will be done in Excel. It will lead to the introduction of the Volga.It is well known that Black Scholes is a model where nearly all of its assumptions are wrong, the smile is the answer of the Markets to this issue. We will analyse the two components of the Smile: Volga and Crisis.Light introduction of the SABR model as it is a representative of the Smile models: you will also perform a Calibration of SABR parametersEventually, we will build a Risk Management System in Excel for WTI Futures and Options. All of the previous concepts will be used to create this Excel, it will show all our Option Greeks. The first version will be built with a Flat volatility for each Future. In a second time, SABR smile will be integrated.A small chapter will study the interpolation methodologies, as they must be carefully chosen. The Risk Management is quiet complex, as always in finance, it is the sum of small simple process and measures, but the devil hides in the details and being wrong in the details will cost you a lot of money.Eventually, the Option Trader Job will be presented, with daily tasks, risk measurement and P&L verification.So this class is a complete overview of the option trading process from theory to practice. It has a lot of material based on Excel, and it is downloadable for the students.

Overview

Section 1: Introduction

Lecture 1 Introduction

Section 2: Normal Law

Lecture 2 Normal Law

Section 3: Option Modeling

Lecture 3 Option Modeling

Section 4: Black Scholes and its vanilla Greeks

Lecture 4 Derivatives and Taylor development (Optional)

Lecture 5 Black Scholes and its Greeks

Section 5: Option Risk Management

Lecture 6 Simple Gamma Risk Management / Replication

Lecture 7 Simple Vega Risk Management / Volga

Lecture 8 Volatility Smile

Section 6: Option Portfolio

Lecture 9 WTI Future Option Book, without smile

Lecture 10 Integration of the Smile

Lecture 11 Volatility Interpolation

Lecture 12 Option Trading

Section 7: Wrap Up

Lecture 13 Conclusion

People who want to know how Options really works,IT programmers who want to know wht the option Trader are doing,Freshman starting a job in a Bank or a Hedge Fund