Abstract
Although financial markets have toyed with the concept of correlation for almost three decades, it is perhaps only in the last 10–15 years that it has become more ‘mainstream’.
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Notes
- 1.
This calculation used a funding rate of 0.25 % and a composite dividend yield of 3.20 %, which was a weighted average of the two underlying shares.
- 2.
Based on notation in Bennett and Gil (2012).
- 3.
For a more detailed analysis of the Greeks, readers are referred to Marroni and Perdomo (2014).
- 4.
All other option input parameters are the same as the previous types of option except the following examples all have a maturity of 1 year.
- 5.
It is assumed that 1 option = 1 share.
- 6.
GBP depreciation means that 1 unit of sterling will buy a smaller amount of USD; USD appreciation can be thought of as having to give up fewer USD to obtain a fixed amount of GBP. GBP appreciation means one unit of sterling will buy a greater amount of USD; USD depreciation means giving up a greater amount of USD to obtain a fixed amount of GBP.
- 7.
Admittedly in the other negative correlation scenario (#3) the composite option does outperform the vanilla but hopefully the reader will be happy to accept the intuition behind the argument shown by scenarios #1 and #4.
- 8.
This is the GBP per share premium of £0.1701 converted at the original exchange rate of £1 = $1.60.
Bibliography
Bennett, C., & Gil, M. (2012) Volatility trading Santander
Bouzoubaa, M., & Osseiran, A. (2010) Exotic options and hybrids Wiley
Brask, A., Baror, E., Deb, A., & Tang, M. (2007) Relative value vehicles and drivers Barclays Capital
Derman, E. (1992) Outperformance options Goldman Sachs
Haug, E. (2007) The complete guide to option pricing formulas McGraw Hill
Magrabe, W. (1978) The value of an option to exchange one asset for another, Journal of Finance, 33 (March 1978)
Marroni, & Perdomo. (2014) Pricing and Hedging Financial Derivatives Wiley
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Schofield, N.C. (2017). Correlation-Dependent Exotic Options. In: Equity Derivatives. Palgrave Macmillan, London. https://doi.org/10.1057/978-0-230-39107-9_8
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DOI: https://doi.org/10.1057/978-0-230-39107-9_8
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