Dynamic Hedging: Managing Vanilla and Exotic Options

Introduction Dynamic Hedging 1

Part 1 Markets, Instruments, People

1 Introduction to the Instruments 9

2 The Generalized Option 38

3 Market Making and Market Using 48

4. Liquidity and Liquidity Holes 68

5 Arbitrage and the Arbitrageurs 80

6 Volatility and Correlation 88

Part II Measuring Option Risks

7 Adapting Black-Scholes-Merton: The Delta 115

8 Gamma and Shadow Gamma 132

9 Vega and the Volatility Surface 147

10 Theta and Minor Greeks 167

11 The Greeks and Their Behavior 191

12 Fungibility, Convergence, and Stacking 208

13 Some Wrinkles of Option Markets 222

14 Bucketing and Topography 229

15 Beware the Distribution 238

16 Option Trading Concepts 256

Part III Trading and Hedging Exotic Options

17 Binary Options: European Style 273

18 Binary Options: American Style 295

19 Barrier Options (I) 312

20 Barrier Options (II) 347

21 Compound, Choosers, and Higher Order Options 376

22 Multiasset Options 383

23 Minor Exotics: Lookback and Asian Options 403

Part IV Modules

Module A Brownian Motion on a Spreadsheet, a Tutorial 415

Module B Risk Neutrality Explained 426

Module C Numeraire Relativity and the Two-Country Paradox 431

Module D Correlation Triangles: A Graphical Case Study 438

Module E The Value-at-Risk 445

Module F Probabilistic Rankings in Arbitrage 453

Module G Option Pricing 459

Notes 479

Bibliography 490

Index 499