Reference no: EM132110697 , Length: word count:3000

Assignment

Part A

Identify an option (in any market in the world) that you believe is mispriced. Illustrate and justify clearly why you think the instrument is mispriced.

Develop an arbitrage, delta-neutral strategy that will profit from the mispriced option. Specifically, detail the minimum costs of undertaking this strategy and pursuing it. You can use as much capital as you like. Given that the strategy is theoretically risk free, you should not lose any money anyway!

Make a record of all transactions and profit/loss of the strategy. You are required to show evidence of at least one re-balancing (even if it is advantageous to close-out early - you can discuss this in your report).

At the end of the two weeks period, evaluate the effectiveness of this delta-neutral portfolio.

Part B

Consider another "greek" to hedge in conjunction with your delta-neutral portfolio in Part A. Explain and justify the objectives and assumptions to hedge this other "greek" in the light of prevailing market conditions.

Create a second portfolio using your delta-neutral portfolio in Part A and making it simultaneously "other greek" neutral at the beginning of the same two weeks period as in Part A. Hold this portfolio (no re-balancing required) for the same two weeks period.

At the end of the two weeks period, evaluate the effectiveness of this delta and "other greek" neutral portfolio.

Part C

Compare the results of your "dynamic hedging" approach in Part A and the "hedge and forget" approach in part B. Discuss and conclude if one approach is necessarily superior than the other, applying the underlying theory to prevailing market conditions.