Options Futures Risk Management Assignment
Assignment type Individual
Assessment weighting 30%
Total Marks 30
Due Thursday, 8th June – by 10:00pm
Word Limit 3,000 words (Arial, Size 12 font, 1.15 spacing)
? Submit your assignment electronically via the Turnitin Assignment tool by 10pm Thursday, June 8. The link for the Turnitin Assignment tool has been created for you under the Assignment page on MyUni. Email submission will not be considered.
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? You are encouraged to make use of the Refinitiv access available to you for your individual research. However, it is a requirement to use ONLY the data provided in the “Assignment Data S1-2023” file for this assignment.
Over the past year, financial markets have witnessed high levels of volatility due to elevated levels of uncertainty caused by disrupted global supply chains; ongoing geopolitical tensions; a surge in global inflation; aggressive tightening of monetary policy; and more recently, concerns over the stability over the global banking system with the recent collapses in Silicon Valley Bank, Signature Bank, Credit Suisse and First Republic Bank.
In this environment, securities (such as stocks and derivatives) often deviate from their fair values for short periods of time, presenting opportunities to exploit mispricing in the derivatives markets (Part A). It also allows for more fulsome fundamental analysis from fund managers, allowing the top fund managers to produce significant alphas (excess returns) from ‘picking winners’ in a volatile market environment (Part B).
Your report must document a complete discussion of the process outlined below, including full details of transactions executed. Good structure, presentation and concise writing skills are likewise important. Your report length must have a word count of no more than 3,000 words (size 12 Arial font, 1.15 spacing), including all discussion, graphs, tables and references. (3 marks) Part A: Volatility Arbitrage
• For your allocated banking stock only (stock 2), calculate and plot annualized historical volatility with annual implied volatility in a graph (show calculations and workings). (2 marks)
• Referring to the graph above, analyse the relationship between historical volatility and implied volatility. (2 marks)
• From your analysis above, develop a delta neutral strategy for a period of your choosing up the option expiry of 20/04/2023 to arbitrage on volatility. You are required to perform at least one rebalancing transaction during the holding period. Explain how the strategy will work and detail all transactions for undertaking the strategy. Justify your decisions (type of option used, start date of the strategy, rebalancing date etc.). You can use as much capital as you like, but both transaction costs and the cost of capital needs to be considered. (6 marks)
• At the end of the period, close all the positions and evaluate the effectiveness of your strategy.
Part B: Hedging Strategies
• Assume you have AUD1,000,000. Create an equally weighted portfolio of your two stocks as at
31 October 2022. Show all calculations and workings. (1 marks)
• On 30 January 2023, you receive news that highlights instability in the global banking sector and believe there is significant downside risk which may impact your Australian banking stock(s). However, in this environment you believe there will be a flight to safe assets such as gold, and are therefore bullish on your gold stock(s). Devise a strategy that has the following objectives listed below and provide a detailed description of all your transactions and consider all costs.
i. Protect the portfolio from adverse movements in the banking stock(s), by using an appropriate options strategy (where the option is held to maturity) from 30/01/2023 (start date) to 18/05/2023 (close out date); and
ii. Protect the portfolio from a market downturn whilst maintaining the full exposure to the unsystematic risk in your gold stock(s) from 30/01/2023 (start date) to 18/05/2023 (close out date) (hint: consider the use of a futures contract).
At the end of the period, close all the positions and evaluate the effectiveness of your strategy. Consider your total portfolio returns from inception (31 October 2022) without the hedging strategies versus the total portfolio returns with the hedging strategies and assess these returns against a relevant benchmark. Was it superior or ineffective? (6 marks)
What are the potential sources of ineffectiveness in your strategy that may contribute to it
performing better/worse than expected? (2 marks)