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nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-24 14:37
Problem of market making in broker book (no LOB)

- Maturity is from 5 minutes upto 1 day.
- Types of options are european, american, barrier etc.

Question is which vols to use for quoting?
1) implied vol (IVol), for calibration there are option series with longer maturities, starting from 1, 2 days onwards to ~1 year.
2) historical vol (HVol) from econometric model featuring ARCH and jumps (?). Add some 20-40% add-on to match the level of IVOL (there are studies that E[IVol-HVol]~20%).

Yesterday I was advocating for IVOL-based valuation, but now I am shifting towards HVol-based one (+add-on).

Broker is not going to hedge his book, but balance the payout losses with revenue from risk premiums on issuance and fees (maybe).

What are the pro's and contra's?
Thanks

IVOL:
PRO - Risk neutral, i.e. reflects current state of the market. Can be used as a hedge (questionable advantage as calibration options are beyond 1 day). Has a smile.
CONTRA - Maturity of calibration instruments are beyond the maturity of marketed products, hence certain features of IVOL, like smile, are less relevant. Stability of implying procedure at super-short term is a question.

HVOL:
PRO - can give reliable value at short maturities. Econ model can deliver forward distribution so I can give a quote directly (e.g. using MC).
CONTRA - as such there is no smile feature. Question: is it needed at all if I can price with MC?

Timing is ~1min or so. It is not high-frequency.

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

silverside


Total Posts: 1446
Joined: Jun 2004
 
Posted: 2021-03-24 15:40
for very short dated options, a diffusion model such as black scholes wont work (even with bumping the vol) unless you add jumps

as to how to calibrate the size and number of the jumps, i defer to expert judgement, but I suggest you apply a very rigorous backtesting, as I can see a chance of you getting picked off by people who have inside information (like - do people really buy short-dated options just for fun?)

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-24 16:04
thank you!

Inside is my first "red flag" for such products, yes. Obvious counteractions are
- to set punishing charge for excessively profitable accounts,
- to limit book size (limited issuance)
- may be more?

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

ronin


Total Posts: 684
Joined: May 2006
 
Posted: 2021-03-24 16:09
Yes, this is those low-rent retail brokers. "Forex" and "binary options".

The way it works in the real world is the punter gets a metrick f***ton of leverage, and the bookie just waits for him to fictitiously trade himself to negative equity, at which point they stop him out and keep his cash. No actual trades take place.

There is a bit of risk mitigation in case the punter wins, but basically they make it very easy to just keep playing until you lose, and hard to pull any winnings out.

How would you price it? Well, o/n iv is useless - you can't hedge it with o/n options. Just some rule of thumb, I guess. I suppose you could go all clever and parametrize intraday vol in terms of VWAP and change pricing depending on where you are on the VWAP curve.

But, in reality, there is no upside to doing that, either for the punters or for the bookes. Once the punter has put money in a website like that, it's gone - it is now bookie's money. It's only the question of how many times the punter clicks his mouse before that happens. There is no amount of quanting that is going to change any of that.

"There is a SIX am?" -- Arthur

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-24 16:18
Yes, sounds like this, indeed.
It's about DeFi exchange and is, therefore, under smart contract.

This brings me to the question that exchange has to put capital aside to guarantee payouts.

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

ronin


Total Posts: 684
Joined: May 2006
 
Posted: 2021-03-24 18:55
> exchange has to put capital aside to guarantee payouts.

As in, gross theoretical exposure? That sounds a bit excessive. 3 times 10d VaR is probably closer.

"There is a SIX am?" -- Arthur

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-24 23:21
> 3 times 10d VaR is probably closer.

What VaR, if in crypto markets, 5-30 minutes move may exceed 3 months of waiting.

These guys dump credit cpty risk into single pool and introduce price adjustment for book asymmetry

https://medium.com/finnexus/designs-to-make-fpo-v1-0-safe-and-secure-afee6a729e1b

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

ronin


Total Posts: 684
Joined: May 2006
 
Posted: 2021-03-25 09:43
No, I meant pnl var.

If it doesn't trade daily, then some longer window. And, until it gets enough history, some multiple of net exposure.

"There is a SIX am?" -- Arthur

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-25 09:52
@ronin

Understood.

Reply to bookie/punter relationships. If all rules are openly shared I do not see any problem with honesty/integrity, however, it is true that such design might be non attractive, who knows.

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

ronin


Total Posts: 684
Joined: May 2006
 
Posted: 2021-03-25 12:04
Yes, it's not actually fraud. The punters are willing participants.

But it does does live in the tails of the distribution, as far as ethics is concerned.

"There is a SIX am?" -- Arthur

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-26 07:45
All book and trading rules of the venue will be transparent and open for reading. What ethics?

Or are you talking about traditional betting platforms?

... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)

deeds


Total Posts: 516
Joined: Dec 2008
 
Posted: 2021-03-26 11:29

everybody here current on the rules of three card monte?

EDIT: apologies, not a comment on the content of the proposed system (though it seems pretty vulnerable, or am i unschooled and unskilled?), but on the idea that transparency is sufficient. It's helpful, frequently in shutting the barn door for the next horse.

ronin


Total Posts: 684
Joined: May 2006
 
Posted: 2021-03-26 12:14
Yes, I was referring to the websites that push that sort of product to retail. There is nothing unethical about the products themselves - hell, their core product is G7 fx pairs.

Putting the products on an exchange is not a bad thing. The only question is, is there enough demand for stuff like that to make the exchange function? Who knows.

The reason it works for retail is because their revenue is 100% of the turnover. For an exchange, it will be basis points of the turnover.


> on the idea that transparency is sufficient

Haha! Transparency in itself only helps when the client is sufficiently skilled to make sene of it. That's why we regulate things like financial services...

"There is a SIX am?" -- Arthur

Strange


Total Posts: 1681
Joined: Jun 2004
 
Posted: 2021-03-26 12:22
> All book and trading rules of the venue will be transparent and open for reading. What ethics?

I have to agree with @ronin here. These things are rather shady from the ethical perspective as you are exploiting peoples addictions more than anything else. The choice is yours, but you are the one who has to look at yourself in the mirror in the morning.

If you assume that you have a diverse enough population of "traders", I would not bother hedging it - just come up with some reserve to make sure you got enough to cover N-th quantile losses given that population.

'Progress just means bad things happen faster.’

nikol


Total Posts: 1377
Joined: Jun 2005
 
Posted: 2021-03-26 13:09
@Strange
>> The choice is yours, but you are the one who has to look at yourself in the mirror in the morning.

The more you shame me, the more it sounds as a joke "Oh, no no no, boy." ))
I really do not see the issue, especially if to compare this type of venue to others in crypto and more traditional finance space (dont forget to replace the LIBOR!). Or maybe I am shameless and focus on what can be done to make things happen?

PS. Talks about ethical money I always find somewhat hypocritical, especially over internet (like politics as well). These need long walks in person and maybe also some beer to smooth the discussion.

>> just come up with some reserve to make sure you got enough to cover N-th quantile losses given that population.

Yes, it crosses with suggestion from @ronin about 10d VaR (IM) type of thing.


... What is a man
If his chief good and market of his time
Be but to sleep and feed? (c)
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