Derivatives (M)
Individual Assignment (25%)
o Submit your assignment electronically via the Turnitin Assignment tool by 9am Tuesday, April 2. The link for the Turnitin Assignment tool has been created for you under the Assignment page on MyUni. You will need to upload your assignment in a Word document ONLY to Turnitin. Email submission will not be considered. Students are expected to submit their work by the due date to maintain a fair and equitable system.
o Statement of Acknowledgement of Original Work
By submitting your assignment, you declare that all material in this assessment is your own work. You have also read the University's Academic Honesty Policy. Please be aware of policy and guidelines regarding plagiarism (see Course Outline for website link).
o Whilst you are encouraged to make use of the Refinitiv access available to you for your individual research, it is a requirement to use ONLY the data provided in the “Derivatives (M) - data for assignment” file for this assignment. You may choose any of the stocks/options from the data file. Assume interest rate is 5%.
Preamble
The threat of inflation and burgeoning interest rates loom large in Australia and much of the world, presenting a different set of challenges, no less. Recent geo-political challenges have been front-of-mind exacerbating macro-economic risks, with heightened volatility seen in the markets. Considering the evolving macro-economic and geo-political challenges, the ability to hedge one’s investment has gained prominence.
In this assignment, you will identify mispriced options to arbitrage and implement a delta hedging strategy to hedge your position, giving due regard to the prevailing market outlook.
Mispriced Options Arbitrage and Delta Hedging (17 marks)
Identify an option (from the data file) that you believe is mispriced.
Assessment criteria:
correct methodology for determining historical and implied volatility.
illustrate and justify clearly why you think the option is mispriced.
cohesive arguments for the volatility arbitrage giving due regard to both specific stock/option and broader market outlook.
Next, develop an arbitrage, delta-neutral strategy that will profit from the mispriced option. Specifically, detail the minimum costs of undertaking this strategy and pursuing it for two weeks. You can use as much capital as you like. Given that the strategy is theoretically risk free, you should not lose any money anyway!
Write a report detailing all your transactions and the rationale behind them and the profit/loss of the strategy. You are required to show evidence of at least one re-balancing (even if it is advantageous to close-out early – you can discuss this in your report). Evaluate the effectiveness of this delta-neutral strategy.
Assessment criteria:
explain and justify the objectives and/or assumptions you make with respect to hedging delta.
correct implementation of strategy.
accounting for all relevant costs.
relevant benchmarking of returns.
completeness of transactions.
evidence of rebalancing.
effectiveness of hedge vis-a-vis your objective, the reasons for its success or failure and how the outcome could be improved.
Stock Valuation (5 marks)
Drawing on the knowledge gained in your EVA course, comment on a suitable methodology for determining if the stock is mispriced. Discuss if such mispricing in the stock would affect the results of your delta hedge.
Assessment criteria:
appropriateness of identified methodology.
cohesive arguments on effect of stock mispricing on delta hedge.
Report Writing (3 marks).
Your report must documenta complete discussion of the process outlined above, including full details of transactions executed. Transaction costs must bear evidence that it is a realistic figure. Good structure, presentation and concise writing skills are likewise important. Your report length must have a word count of 2,500 words (size 12 font, single spacing), including all discussion, graphs, tables, and references.