MANAGING POSITIONS PRE- AND POST-TRADE

For educational purposes only. For professional and institutional clients only
Introduction

 GABRIEL MANCEAU
Barclays, Volatility Trader

 ANTOINE DELGA
Bloomberg, Equity Derivatives Application Specialist

3
Managing Positions Pre- and Post-Trade

 Option Valuation & Risk Measures

The Greeks Vega Liquidity
Volatility Trading Map

 Volatility Analysis and Trade Decisions

Pre-Trade Rich VS Cheap Volatility
Volatility Trading Map

 Trading risks and challenges

Post Trade Convexity Trading
Are Underlyings really lognormal?Tail Risk

Source: Barclays, Bloomberg

You should not rely on historical or hypothetical historical information. Such historical and hypothetical historical information is not indicative of future performance

3
Option Valuation & Risk: Measures – the “Greeks”

Greeks Definition
Vega Liquidity
Delta and Realized Volatility
Introduction : What is Implied volatility?
Strike

Forward Maturity

Log Normal
Implied vol Diffusion Option price
Black and Scholes

Volatility surface for a given underlying by translating all options prices for all strikes
and maturities
Explain the price of options  can calculate sensitivities to model inputs: no Model
No Greeks!
Simplify options prices to one variable  common language for comparing any
option price

 Exotics products: options prices  Model taking inputs, trades specific  portfolio
price
 Any input variable can lead to a Greek

5
Greeks
Direct Greeks
 Spot:
Delta Change in price in £ for 1% move in spot -> P&L = spot return in % * delta

Gamma Change in delta for 1% move in spot -> P&L = 50 * gamma * (spot return in %
)^2 Rates (rho), repos (repo rho), dividends (dividend risk): forward
determination
 Volatility:

Vega Change in price in £ for 1 point change in implied vol (additive) -> P&L = vega *
vol move
 Time:
Change in price in £ for 1 day move forward . “Break-even”^2 = theta / (50 *
Theta gamma)

Cross Greeks
Vanna Absolute change in delta in £ for a 1 point additive move on the vol -> the skew
greek
Model Greeks
From model inputs (exotics): model parameters sensitivities

6
Options Risk Measures – “the Greeks” OVME <GO>

 Greeks profile for a call on euro stoxx : SX5E Dec 13 C2900 Index
We can observe the profile of each greek of this call for a price variation
at different dates:
 How to trade vega? MARS <GO>
Example of a volatility strategy

 Buying 4500 Straddle 2900 Sept 14

`

 Our portfolio is worth 19.5 M and we have 5.17% in vega, equivalent to EUR 1 Million

 The Impact of a Volatility change as of now is linear

8
 How to trade vega? MARS<GO>
Example of a volatility strategy

 Buying 4500 Straddle 2900 Sept 14

`

 The Impact of a Volatility change as is still linear but the drift weakens as time goes by

9
Greeks risk management for Volatility Portfolios
Spot ladder on Greeks

 On a portfolio with various volatility strategies and assets

Spot Greeks
Shift P&L Change Delta Gamma Vega Rho Theta
-20.00% (16,993,217) 51,735,140 8,220,296 1,363,975 (43,394) (143,455)
-10.00% (6,634,572) 99,412,791 (4,436,269) 840,225 (22,293) (64,047)
-8.00% (4,559,178) 88,357,043 (7,301,477) 626,217 (18,617) (49,533)
-6.00% (2,824,505) 72,330,260 (8,879,257) 397,743 (15,175) (42,842)
-4.00% (1,487,144) 54,627,604 (8,937,058) 174,869 (11,956) (41,856)
-2.00% (540,331) 37,043,078 (9,475,732) (50,208) (8,938) (41,882)
-1.00% (213,307) 27,058,775 (11,171,663) (164,252) (7,502) (34,281)
0.00% - 14,927,662 (13,670,430) (280,638) (6,113) (23,666)
-1.00% (213,307) 27,058,775 (11,171,663) (164,252) (7,502) (34,281)
0.00% - 14,927,662 (13,670,430) (280,638) (6,113) (23,666)
1.00% 75,999 (125,065) (16,566,740) (394,063) (4,769) (10,243)
2.00% (11,276) (18,026,021) (19,056,298) (496,058) (3,462) 1,341
4.00% (724,290) (54,589,272) (16,342,166) (634,769) (898) 1,874
6.00% (1,998,915) (74,935,960) (2,642,287) (665,131) 1,733 (24,620)
4.00% (724,290) (54,589,272) (16,342,166) (634,769) (898) 1,874
6.00% (1,998,915) (74,935,960) (2,642,287) (665,131) 1,733 (24,620)
8.00% (3,365,551) (66,104,799) 13,790,487 (612,421) 4,562 (67,496)
10.00% (4,284,055) (29,904,304) 26,914,564 (517,109) 7,658 (98,198)
15.00% (1,987,823) 161,786,414 64,092,775 (23,615) 16,811 (166,326)

10
Greeks risk management for portfolios
A more advanced Vega risk management

Maturity TOTAL
Strike Strike% July August September December March All Maturity
0 0.0% 4 -28 346 -204 552 669
143 5.0% -25 163 -1,958 1,096 -2,880 -3,604
285 10.0% 41 -257 3,042 -1,686 4,128 5,267
713 25.0% -87 480 -5,958 -488 -27,121 -33,174
1140 40.0% 486 -1,709 14,739 1,104 9,724 24,343
1425 50.0% -965 10,680 -78,125 46,225 -12,843 -35,028
1995 70.0% 521 -31,621 30,812 153,319 41,128 194,160
2280 79.9% 8,321 -76,021 -30,169 101,920 14,353 18,403
2565 89.9% 13,711 -328,278 523,492 243,061 76,810 528,797
2708 94.9% 28,491 -213,970 151,962 53,749 12,475 32,708
2779 97.4% 26,149 -116,902 -113,579 10,276 -16,000 -210,055
2850 99.9% 87,993 -5,323 -69,799 38,532 1,356 52,759
2921 102.4% -29,748 -117,137 -405,265 2,652 -12,977 -562,475
2993 104.9% 5,055 97,600 -322,165 -23,136 -45,489 -288,135
3135 109.9% 5,587 -34,307 -40,942 49,303 -12,590 -32,949
3420 119.9% -354 5,983 -10,848 30,307 6,993 32,081
3705 129.9% 105 -1,119 5,123 9,687 4,479 18,275
3990 139.9% -30 306 -1,507 -1,851 -1,147 -4,228
4275 149.9% 8 -79 385 432 -156 590
4560 159.9% -2 15 -74 -82 -37 -180
5700 199.9% 0 -0 2 2 0 4
11400 399.7% -0 0 -0 -0 -0 -0
42750 1498.9% 0 -0 0 0 0 0
Total 145,261 -811,523 -350,487 714,219 40,758 -261,771
WeightedTotal 506,682 -2,214,875 -763,084 1,052,746 48,385 -1,370,147

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 Vega Liquidity in the world

Avg daily America EMEA Asia

Vega traded
in M
SPX/VIX > 150M

50M

SX5E/V2X

10M
APPL, Russel, Nasdaq, FTSE, DAX

5M
Facebook, Google, NKY
EEM, PCLN,TSLA

1M
NFLX, MSFT,AMZN, C, FSTMIB, SMI, CAC, TPX, KOSPI, AXJO,
LNKD, EFA, XLF, JPM SX7E, AEX, TOP40 HSCE, HSI
500k

12
SPX/VIX liquity

13
Delta and Realised Volatility GV <GO>
 options “naked-delta” and options delta-hedged is a completely different trading
 delta hedged trading: price based on the implied volatility (market sentiment), PL on the realised
volatility:
 Realised volatility (RV) = a measure of the past fluctuations of the spot
 Realised volatility is linked to the Black Scholes theory: it is the best-guess for the volatility that
should have been used in the option pricing formula.

3 Month realised vol for SPX, SX5E, FTSE, NKY

14
Pre-Trade : Volatility Analysis and Trading Decisions

Rich VS Cheap Volatility

Volatility Trading Map
Determining “Rich” vs “Cheap” implied volatility

1. Use a data analysis tool to calculate the realised volatility for multiple time periods

2. Compare realized volatility to the current implied volatility in the options

3. Repeat this procedure for similar underlying assets, then compare spreads of
implied volatility to realized volatility

4. Consider any asset-specific catalysts (earnings, pending announcements or

macroeconomic factors) that may justify the presence of a particular spread

16
Pre-Trade: Rich vs. Cheap Analysis VCA <GO>
Volatility Analysis

 Comparing the implied with realized volatility for the main global indices

 Volatility is quite expensive around the globe

17
Pre-Trade: Rich vs. Cheap Analysis GV <GO>
Volatility Analysis

 On the Euro Stoxx ATM 3 month VS 3month histo, a recent turn to rich
after some hieratic cycles

18
Pre-Trade : finding the good entry point GV <GO>
Historical evolution of the SX5E 1 year historical volatility

 Looking at the realized volatility over the last year. we are at the minimum!

19
Pre-Trade : finding the good entry point GV <GO>
Historical evolution of the sx5e atm 1 year implied volatility

 Looking at the volatility over the last year. we are within the 9th percentile of the
lowest volatility.
This is a very low entry point

20
Pre-Trade : finding the good entry point GV <GO>
Historical evolution of the 1 year volatility richness

 … then we are now in a rich volatility regime

21
Pre-Trade : finding the good entry point GV <GO>
Historical evolution of the 1 year volatility richness

 … then we are now in a rich volatility regime

22
Pre-Trade : finding the good entry point SHOC <GO>
Using historical analysis to determine best and worst entry for a long volatility
trade: SX5E Straddle
 Looking at the best entry point study, we can see that the current vol is 18.88
 The lowest implied volatility was at 17.86 (-1.02 compared to now)
 The average implied volatility was at 20.24 (+1.36 compared to now)
 The highest implied volatility was at 23.50 (+4.68 compared to now)
Creating the relevant shocs

23
Pre-Trade : finding the good entry point MARS <GO>
Using historical analysis to determine best and worst cases

 We can see how expensive or cheap becomes the Straddle according to the
different Implied Volatility levels

24
Pre-Trade : Comparing Historical Volatility for Similar
Underlying Assets GV <GO>
Comparing Realized and Implied vol for the SX5e – SPX spread

25
Case Study: Spread VSTOXX - VIX
Analysing the Spread

 The spread has been very rarely negative

26
Case Study: Spread VSTOXX - VIX
Looking at the term structure this days

 The Term Structure is pretty much constant around 3

27
Case Study: Spread VSTOXX - VIX
Analysing the Spread

 However in the past like in end of 2011, there was better spreads opportunity…
… Like a back-end future spread around 2.5

28
Pre-Trade : Comparing Historical Volatility for Similar
Underlying Assets GV <GO>
Analyzing richness of SX7E

 From a 13 low to highs spiking at 80: A clear Vol regime change on the EUR
Banks Index

29
Pre-Trade : Impact of an Event on Volatility GV <GO>
Historical evolution of the sx7e atm 1 year implied volatility

 Focusing on the Euro Stoxx EUR Bank index (SX7E Index), we observe a huge
turn on volatility richness due to the concern on banks solvency raise in the
context of the European Sovereign Crisis

30
Case Study: Variance Swap
What is a Variance Swap?

𝑉𝑒𝑔𝑎 𝑡𝑟𝑎𝑑𝑒𝑑
 Payout = × (𝑅𝑒𝑎𝑙𝑖𝑧𝑒𝑑 𝑉𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦 2 −𝐾 2 ))
2∗𝑆𝑡𝑟𝑖𝑘𝑒
quadratic payout (K is the fair volatility)
 Constant gamma over life-time of the trade
 Theoretically replicable by a strip of options

 Delta resets everyday

 More expensive than straddle  price for downside protection
position: long 1M vega sep14 SX5E @ 22

31
Case Study: Variance Swap OVME <GO>
Example of a SX7E Var Swap

 Buying a 12/30/11 SX7E Var Swap on 01/01/11:

 Locking a 35.30 Volatility on June,2…

32
Case Study: Variance Swap OVME <GO>
Example of a SX7E Var Swap

 Buying a 09/10/13 SX7E Var Swap on 06/02/13:

 We can see the money earned between end of August and November
33
Pre-Trade : Vol of Vol Trading
Volatility Assets Comparative

 Forward variance: pays the square of realised volatility between 2 dates in the future
Fair strike depends on the expectation of the future realised volatility
No exposure to realised volatility until first date reach
P&L only depend on implied vol until first date is reach
Quadratic vega exposure (vega doubles when vol doubles)
 Vix / V2X future:
Vix/V2X futures expires on the fair strike of a 30 days variance swap
P&L linear in volatility
Vega exposure constant
cheaper than forward variance
 Both Implied volatility exposure, no gamma, but roll down/up theta
 Both No daily delta-hedge
 On Vix/V2x future expiry: VIX index = Future expiring = Fair strike of 30 day variance

34
 Pre-Trade : Vol of Vol Trading
Case Study: Forward Var / volatility futures
Short 1M vega V2X nov13 future @ 19.8, Long Nov/Dec forward var @20.4 -> flat risk ?
80,000,000

70,000,000

60,000,000

50,000,000

40,000,000
V2X Future
30,000,000 Fwd Var
Strategy p&l
20,000,000

10,000,000

-
- 10 20 30 40 50 60
-10,000,000

-20,000,000
V2X Expiry Level
Max down P&L: 600 000 at 20.4 expiry level
Breakeven: under 15.5 and over 25.5
Example of P&L for a 40 Vol: 8.8 M

35
Pre-Trade: Skew Trading GV <GO>
Skew Historical Analysis
 Looking at the 1 month skew

36
Case Study : Risk Reversal OVME <GO>
Trading spot/vol dynamic
 Based on negative correlation between spot and implied volatility

 Long Put Short Call dynamically delta hedged

5K dec13 2500/3200 rr, ref future = 2880
120M notional, 110K gamma, 22k vega, 16%
delta
-2.8M vanna but -5K theta
 Scenario
Vol Up 1%, Spot Down 1% : New Delta -2.8 M
Buy 2.8 M Delta
Market back to flat: P&L = 23K on the day

37
 Trading Risk : Skew Trade
Looking at the skew differently : Sorting returns by Vol and Spot Trend

 How did this trade work in the last 2 years

2% 2.0%
1mth fixed strike vol move 2012 1mth fixed strike vol move 201
1.5%
1%
1.0%
0% spot move
0.5%
-1% spot
0.0% move
-2%
-0.5%

-3% -1.0%

-4% -1.5%
-4% -3% -2% -1% 0% 1% 2% 3% 4% -3% -2% -1% 0% 1% 2% 3%

In 2012 In 2013

spot move vol move 2012 2013

+ - 62% 67%
- + 54% 65%

38
Post-Trade:Trading risks and challenges

Pin risk
Convexity Trading
Tail Risk Exposure
Are Underlyings really lognormal?
Summary of Volatility Assets exposure

Property Options Variance Swaps Forward Variance Swaps VIX Futures

Need to Delta-Hedge    
Gamma Exposure    
Theta Exposure    
Exposure to Realised
Volatility    
Exposure to Implied
Volatility    
Exposure to Interest
Rates / Dividends    
Listed/OTC Listed OTC / Listed OTC / Listed Listed

Convexity OTM/ ATM    

Source: Barclays.

You should not rely on historical or hypothetical historical information. Such historical and hypothetical historical information is not indicative of future performance

40
Theory limit with continuous : Pin Risk
Short an option expiring in 15 days with implied volatility around 18, delta hedged

Spot Deviation to the Strike (in %) Spot Deviation to the Strike (in %)
4
4

3 3

2 2

1 1

0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

-1
-1

-2
-2
 Two equivalents spot realisation: One has a 4% move at the beginning of the
period, the other at the end: Which one do you prefer?...

 Applying this reasoning to a 9000 SX5E 2900 Sept 14 Long Call, one day
before expiry, 1% below the strike with a vol around 18 and 12% Delta
Option Out of The Money still holding 150K premium to lose
Max loss 460K if spot expires at 2900, break-even [-0.5%,+1.2%]
41
Convexity Trading

 Selling volatility performed well since 2008.

Barclays short 1Month SPX variance swap systematic strategy

42
Convexity Trading

 S&P 20 years daily return probability comparison

 Historical distribution versus distribution implied by options prices and implied vol
model 45.00%

Probability 40.00%

35.00%

30.00%

25.00%

Historical Proba
20.00%
Predicted proba
15.00%

10.00%

5.00%

0.00%
-4.0%
-9.0%
-8.0%
-7.0%
-6.0%
-5.0%

-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
-10.0%

10.0%
11.0%
12.0%
Daily return

43
 Convexity Trading
Ratio
10.00 Ratio
9.00 500.00
450.00
8.00
400.00
7.00
350.00
6.00
300.00
5.00 250.00
Ratio
4.00 Ratio
200.00
3.00 150.00
2.00 100.00
1.00 50.00

- -
-7.0% -2.0% 3.0% -7.0% -2.0% 3.0%

Tail risks are underestimated more than billion time…

Ratio
9,000,000,000,000.00

7,000,000,000,000.00

5,000,000,000,000.00
Ratio
3,000,000,000,000.00

1,000,000,000,000.00

-15.0% -10.0% (1,000,000,000,000.00)

-5.0% 0.0% 5.0% 10.0% 15.0%

44
Post-trade : Tail Risk with Naked Put
 Let’s remind us the profile of a Naked Short Put

 For a sole variation of the spot, shorting 40k dec 1900 Put gives us a EUR 400k gain.
 On the other side of the coin, we have an infinite potential loss, for example, a
downside shift of -40% on the Euro Stoxx would cost us almost 60 m…

 … Sizeable losses when stress testing the strategy for the worst market conditions in
recent years

45
Post-trade : Tail Risk with Short Call

 Strategy: sell 10M notional Nokia 1M atm call at 40% vol, 50% delta, 10K vega, 400K
premium
Expected P&L, 1.2M a year
Stock up 50% 03/09 opening auction  2.5M loss

 Nokia realized volatility before the spike :

46
Theory Limit and trading behaviors
 How log normal an underlying is?
beware of the underlying you are selling/buying
 Spot jumps while theory assumes continuous diffusion
 Beware of break-even thinking: portfolio with 5K theta, 1M gamma
5𝐾
break-even = = 1% (equivalent to 16% volatility)
1𝑀∗50

 day1: +1%, day2: -1% , day3 :+1%, day4 :+1%, day5: -1% : 1% avg move, 16%
realised volatility
 day1: 0%, day 2 : 0% , day3 : 0%, day4 : 0%, day5 :+5% : 1% avg move, 35%
realised volatility
Convexity rule: realised volatility >= volatility calculated from the average of the move
 Selling tail risk: high probability of a positive P&L, what about the expectation ?
 Trader’s dilemma: 2 losing strategies. Which one you may finally follow ?
 Strategy 1: +15K 4 days / 5, -80K 1 day / 5-> P&L expectation: -1M a year
 Strategy 2: +10M 9 years /10, -100M 1 year /10 -> P&L expectation: -1M a year

47
Thanks for your attention!
Any questions?

GABRIEL MANCEAU
Barclays, Volatility Trader
ANTOINE DELGA
Bloomberg, Equity Derivatives Application Specialist
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49
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NO GOVERNMENT OR This Product is not protected by the Financial Services Compensation Scheme or any other government or private protection
OTHER PROTECTION scheme.
PERFORMANCE DATA BARCLAYS MAKES NO REPRESENTATIONS AS TO FUTURE PERFORMANCE. Past performance is not a reliable indicator
of future performance. We make no representation as to the accuracy, completeness or reasonableness of any performance
data, modelling or scenario analysis in these materials.
BACK-TESTING BACK-TESTING HAS SIGNIFICANT LIMITATIONS. Back-testing does not reflect actual historical performance and is backward
looking. Be cautious when using historical data to assess hypothetical performance before issue.
OPINIONS SUBJECT TO All opinions and estimates are given as of the date hereof and are subject to change. Barclays is not obligated to inform you of
CHANGE any change to such opinions or estimates.
PERFORMANCE OF SHARE THE PERFORMANCE OF SHARES IN AN INDEX IS UNPREDICTABLE. It depends on financial, political, economic and other
INDICES events as well as the share issuers’ earnings, market position, risk situation, shareholder structure and distribution policy.
INDEX RETURN AN INDEX RETURN MAY BE LOWER THAN THE ACTUAL RETURN ON THE CONSITUENTS OF SUCH INDEX. Indices may
not take account of dividends and other corporate actions and may deduct fees and commissions. An investment in an index
may be taxed differently to a direct investment in the components of the index.
SPONSOR ACTION THE INDEX SPONSOR MAY CHANGE THE INDEX. It may adjust the composition or calculation methodology and may
suspend or cancel the index. This will affect the performance of the Product.
INDEX SUBSTITUTION THE INDEX MAY BE SUBSTITUTED IN CERTAIN CIRCUMSTANCES. Such action may negatively affect the value and
performance of the Product.

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