Replicating Plain Vanillas with Plain Vanillas

Gamma · Post by **Gamma** » Tue Apr 15, 2008 4:54 pm

Hi,

I´ve got a little question:

How can I replicate a plain vanilla option with several other plain vanillas?

What I like to do, is to trade a 5 day call, but there`s no such call in the market. So I have to replicate it with longer dated options. Is there a excel sheet or more advanced software available to find out, how to replicate those options?

Thanks

FDAXHunter · Post by **FDAXHunter** » Tue Apr 15, 2008 5:03 pm

You cannot replicate it.

Baltazar · Post by **Baltazar** » Tue Apr 15, 2008 5:17 pm

only with one 5 day put if they both are european

Gamma · Post by **Gamma** » Tue Apr 15, 2008 5:19 pm

Is it really impossible?

If I look at all the fancy exotics and hedging them with vanillas, i thought there must be a way to replicate plain vanillas as well. Is it possible to get a proxy?

Thanks

shortvol · Post by **shortvol** » Tue Apr 15, 2008 5:28 pm

Sure, take a position the underlying..... How much of the underlying and how often to rebalance....that's where it starts to get more tricky.....

granchio · Post by **granchio** » Tue Apr 15, 2008 9:58 pm

>Is it really impossible?

yes, in the real world it is impossible.

additionally:

>If I look at all the fancy exotics and hedging them with vanillas,

do you actually believe those fancy hedging strategies work?

Martingale · Post by **Martingale** » Tue Apr 15, 2008 10:29 pm

I think the answer is no is simple, if you say vanillas you mean Europeans, then those only give you information on terminal distribution of the underlying for longer maturities, and they are not related in a close way to terminal distributions of shoter tenors for your positions.

chiral3 · Post by **chiral3** » Tue Apr 15, 2008 10:41 pm

You can't replicate it in the literal sense. What people do is take a number of options with a weight average maturity of desired ttm. However you have tracking error (or payoff mismatch, what ever you want to call it). If a liquid index future there are some ways that you can lock in profit from futures trades that offset th losses from the ttm mismatch.

I don't think this will help with your 5 day example, though.

SirAppleby · Post by **SirAppleby** » Wed Apr 16, 2008 4:52 am

>What I like to do, is to trade a 5 day call, but there`s no such call in the market.

What about the OTC market? If you using strikes well out of the money, then premiums for the necessary notional amount should not be too much. I am sure there are several dealers who would love to have you as a customer.

sabrewulf · Post by **sabrewulf** » Tue May 13, 2008 6:07 pm

have you looked at ig cfd - they quote weeky options. not great spreads though.

- CSH