Need a favor from the community. Was interviewing a guy today and asked him a few intermediate options questions. Since he failed to answer any of them, I wanted to check if people find these questions overly difficult.
(1) When would you early ex an American call? Is there any uncertainty and how does it manifest? Is there a situation when you would early-X an American put?
(2) Why is it dangerous to delta-hedge a far-OTM options position? Which would would be more dangerous, long or short?
(3) Could you imagine a situation where a call will have delta greater than a 100%?
It would be really awesome if you can PM me the answers. I promise to post the right one here tomorrow, but I really would like to figure out how many people answer these right and what level they felt these question are.
hmm. I only took option classes in undergrad, dont really use them professionally (cash equities instead), that being said the answer of the top of my head would be...
I'm not going to go back through my old derivatives notes from undergrad but I believe there is a situation where it as advantageous to exercise an (American I believe) option early.
These are way too hard for an undergrad imo.
1 is easy 2a is tricky but 2b is easy 3 i have no idea
for reference, i'm a graduating senior who rotated on an equity derivatives desk
The guy claims to have worked on an options trading desk overseas, so I assumed he knows something. The first two questions are tricky and can be discussed in depth, especially the American options ones, lot's of corner cases and things to think about. The last one is definitely very tricky, though I asked it first assuming he's pretty advanced.
I see, these questions are probably fine for someone who has worked on an options desk. Are you at a fund, bank, or trading firm? And did he give reasonable answers even if wrong?
Those are hard questions
For context, I am 2 year analyst
Saw this too late to respond, but thanks for this, these were fun to think about. A few questions if you have time: 1. Got the put side, but was curious about the call side since in an ideal black scholes world where you could sell the option, the price would include the dividend and would generally be the better choice since you also don’t give up the extrinsic value (is it the case in practice that you often can’t find someone to take the other side in time to get the dividend?). 2. Got this one too, but I can see a possible confusion since there might be some path dependency to the positions (e.g. the argument clearly makes sense to me if the questions is whether you should go long an otm option and hedge it, but seems less valid relative to the short side if you imagine that you’re already long the option ). 3. Didn’t get this one at all, but if we assume sticky deltas and a steep enough skew then this seems possible (is there some no arbitrage argument for why this doesn’t make sense or is it just impractical).
Btw I’m a quant who used to price some slightly exotic commodity options so the put funding stuff was included in the first thing I read on American options, dividends were a non factor, and the not hedging long otm options came up in practice a couple of times.
gamma is not greatest otm
you're right, ATM
These seem reasonable to me for anyone with experience.
I got about half right and I’ve never read any options book. I should know this stuff and can’t tell you why I’ve never done it.
I’ve traded options like a guy whose naturally good at math would but never studied. So running some sort of probability thru my head..... basically I’m likely giving away a small edge to citadel or whichever shop is filling me.
Usually betting on something the market maker isn’t. Sometimes right sometimes wrong.
I’m sorry for my ignorance but I don’t know what any of this is. Was this an interview for S&T at the undergrad level or something else? Definitely not IB right? Sorry I’m not much help I’m just someone who has been preparing and haven’t learned any of these technicals, but this stuff sounds interesting? Is it quant related?
Question 2 - easy Question 3 - hard, it's very specific and you need to know about that particular situation. Retarded question to ask in an interview, as it's either he knows or he doesn't, so you won't actually get an interesting discussion if he doesn't know or be able to test the candidate. Question 1 - there are multiple ways to answer this, not necessary technical ones. You have reasons outside the dividend to collapse out of a trade. So you can get to see the guys' thinking which is the idea behind an interview. And it's not just hedge against box bull shit - but simple as, you are pissing money away on some positions and need to meet a margin call. It's open to interesting thoughts.
Anyways, I did ask the same three questions from a friend of mine who runs a large equity index book. He did not have any trouble, #3 included, but he certainly felt that all 3 were way above anything I can get for the money that I am hoping to pay.
hahahaha that's key the last bit. But that said - a lot of extremely clever awkward guys out there, also you'll be better off interviewing non Americans if you are in the US. There is a reason why every single options trading desk is French. You'll get a Frenchman for cheap
Number 1 is easy. But I think number 2 and 3 can only be answered if you've worked on an option desk usually. These are stuffs I've never come across in books.
Great questions none the less. Learned something new today.
My take on Question #2 is a little different. To get the answer you were going for, it is usually asked this way: is it possible to lose more than your premium by being long an option? This is a little sneaky, because the answer is "yes, by delta hedging it" and then you describe exactly the scenario of a delta-hedged OTM option expiring at the strike.
For me the reason not to delta-hedge a far OTM option is that you need to be way too clever for anything you do to actually work, namely:
You need to estimate your own vol. Tail options trade on some sticky price, and their market vol is a meaningless number. Consequently, so is their BS-delta
You need a view on spot-vol behavior. Even the "correct" BS-delta (using a "correct" vol), will be wrong, so you need a "smile delta". And who knows if that's the way the surface will actually behave
Now I'm gonna assume you don't traffic in tail options for a living (not sure what CIO would let you do that...) so if you do have a tail in your book it likely because it was a "reasonable" option that drifted away. That would imply your notional isn't all too big (was originally sized for reasonable greeks at a 50 or at least 20 delta). That would imply your Gamma on this thing is minuscule, so really, what's the point.. Especially if there's non-negligible bid/off on the underlying
What I'd do if it's near expiry is make an intuitive, non-model based decision. I'd look at and decide if it's 0-delta, 25-delta, or 50-delta. My bias would typically be toward 0-delta
Question #1 is fair and anyone looking for any vol related job should expect to be asked this. Question #3 is challenging, really a corner case for 100 delta options subject to stock-type settlement. Think a more interesting one is what is the delta of a long-dated, say 2yr, synthetic forward (long call, short put) on a stock index? Is it 100 / more / less?
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