Apols the strat should have read "buy" ATM and sell longer dated wings....
On 26 Jun 2011, at 19:03, tbrowne wrote:
> Very helpful thanks Krishna. Yes I have access to the wholesale market so liquidity is not a problem but as you say bid/offer can be a challenge in EM, although it's gotten much better in the past few years.
>
> Do you have any ideas on packages I might use for pricing in R? I am typically going to be trading everything from ATM up to 10 delta, and on only occasionally 5 delta. I need to backtest strategies where we sell short dated ATM and sell longer dated wings (the idea is that in the current highly regulated environment, wings are expensive as policy makers are restricting big moves. Yet short-dated chop is high). So before I get into the backtesting modules of R, I first need a reliable pricer for a single options.
>
> Thanks,
>
> Tom
>
>
>
>
> On 26 Jun 2011, at 16:46, krishna wrote:
>
>> I think the easiest is to fit a quadratic function to fit the smile. There is an old Malz (1997) paper that describes this
>> http://papers.ssrn.com/sol3/papers.cfm?abstract_id=943500
>>
>> However there are some small issues with this approach when you have large RR and also the quoting conventions are important (EM vs G10).
>>
>> So his approach is to make volatility a quadratic function of delta this allows you to have some closed form type formula for the vanna and volga.
>>
>> So you could do something like this
>>
>> smilefit<- lm(vol ~ delta + I(delta^2))
>>
>> then use the fitted function to price your particular delta option. You'd also have to interpolate between maturities as the option decays.
>>
>> I don't think there is any single model that you can use for the very low delta options (less than 10 delta) typically people use various power functions to interpolate but it is in practice very liquidity driven.
>>
>> Also as you probably know a prop desk or large HF will get much tighter pricing than if you are trading this on a retail FX platform or if you are at a small fund so you'd have to make reasonable assumptions on bid-offer.
>>
>> Hope this helps.
>>
>> Cheers
>> Krishna
>>
>>
>>
>> On Jun 23, 2011, at 5:17 PM, thomas.browne@mac.com wrote:
>>
>>>
>>> Hi,
>>>
>>>
>>> I want to price FX options taking into account the smile and skew. Here is the vol data that I have, for example for EURUSD:
>>>
>>> EURUSD
>>> 1m
>>> 3m
>>> 6m
>>> 12m
>>> 2y
>>> 10dPut
>>> 16.6
>>> 17.4
>>> 18.0
>>> 18.4
>>> 17.6
>>> 25dPut
>>> 14.7
>>> 15.2
>>> 15.4
>>> 15.7
>>> 15.2
>>> ATM
>>> 12.9
>>> 13.3
>>> 13.4
>>> 13.6
>>> 13.4
>>> 25dCall
>>> 11.8
>>> 12.3
>>> 12.5
>>> 12.8
>>> 12.6
>>> 10dCall
>>> 11.2
>>> 11.9
>>> 12.4
>>> 12.8
>>> 12.6
>>>
>>> Alternatively I have it in butterfly and RR form:
>>>
>>> EURUSD
>>> 1m
>>> 3m
>>> 6m
>>> 1y
>>> 2y
>>> 10dfly
>>> 1.04
>>> 1.41
>>> 1.76
>>> 1.96
>>> 1.71
>>> 25dfly
>>> 0.36
>>> 0.45
>>> 0.54
>>> 0.62
>>> 0.55
>>> ATM
>>> 12.89
>>> 13.27
>>> 13.43
>>> 13.61
>>> 13.38
>>> 25drr
>>> -2.98
>>> -2.92
>>> -2.92
>>> -2.93
>>> -2.56
>>> 10drr
>>> -5.43
>>> -5.46
>>> -5.61
>>> -5.59
>>> -4.95
>>>
>>> Source: Bloomberg.
>>>
>>> What is the best library to do this in R? Is there a library to do this?
>>>
>>> Basically I am running model portfolios using options up to 2 years and as low as 5 delta. So I would need to price the options using the smile/skew, and also potentially extrapolate the surface to lower delta vols. I won't be going out further than 2y.
>>>
>>> Separate question: is there a good library for calculating financial trading dates in R, hopefully also taking into account country holidays?
>>>
>>> I am told that Quantlib will do this, but I find it a little dense to understand. If the answer is that I must persevere with Quantlib then so be it, in which case, are there any example sites that I can consult? Alternatively if there is some canned functionality elsewhere that would be good to know. Thanks very much in advance.
>>>
>>> Tom
>>>
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>>>
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>>
>
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