Hi All,
A risk manager told me that the Risk of an option will be the same as the risk of a future option because of the small convexity effect that is in a future (assuming same strike and same option maturity).
I have some questions regarding this. Let's take 6 month Call EUR/RUB Option with 45 as strike and 6 month Call EUR/RUB Future Option with 45 as strike (future will mature 3 months later). Let's assume the RUB rate is 7% and EUR rate is 2% and that the EUR/RUB is today 40. So according to the risk free arbitrage formula the EUR/RUB in 6 months should be equal to 40 * exp[(0.07-0.02)/2] = 41 (this later is then the estimated spot EUR/RUB in 6 months)
-> Suppose now that the RUB will increase in the next 6 months and that EUR/RUB in 6 months is 30. Normally the future price should converge to the spot 30 and neither the 6 Month Call EUR/RUB Option buyer, nor the 6 Month Call Future EUR/RUB Option Buyer will exercise this option.
-> Now imagine that RUB will fall in the next 6 months and that EUR/RUB will be equal to 44. Like before Option and Future Option buyer will not exercise this option (Future price will also converge to spot 44)
-> Do we have the same risk because the future price is always converging to the spot and so we compare similar product at option maturity? is this reflecting the small convexity effect?
Thanks,
A risk manager told me that the Risk of an option will be the same as the risk of a future option because of the small convexity effect that is in a future (assuming same strike and same option maturity).
I have some questions regarding this. Let's take 6 month Call EUR/RUB Option with 45 as strike and 6 month Call EUR/RUB Future Option with 45 as strike (future will mature 3 months later). Let's assume the RUB rate is 7% and EUR rate is 2% and that the EUR/RUB is today 40. So according to the risk free arbitrage formula the EUR/RUB in 6 months should be equal to 40 * exp[(0.07-0.02)/2] = 41 (this later is then the estimated spot EUR/RUB in 6 months)
-> Suppose now that the RUB will increase in the next 6 months and that EUR/RUB in 6 months is 30. Normally the future price should converge to the spot 30 and neither the 6 Month Call EUR/RUB Option buyer, nor the 6 Month Call Future EUR/RUB Option Buyer will exercise this option.
-> Now imagine that RUB will fall in the next 6 months and that EUR/RUB will be equal to 44. Like before Option and Future Option buyer will not exercise this option (Future price will also converge to spot 44)
-> Do we have the same risk because the future price is always converging to the spot and so we compare similar product at option maturity? is this reflecting the small convexity effect?
Thanks,
