Historical Analysis of Exotic Options: A General Framework

Peregrine Securities, 2013

24 Pages Posted: 22 Apr 2016 Last revised: 28 Apr 2016

See all articles by Anthony Seymour

Anthony Seymour

University of Cape Town (UCT)

Florence Chikurunhe

Peregrine Securities

Emlyn James Flint

Legae Peresec; Department of Actuarial Science, University of Cape Town

Date Written: March 14, 2013

Abstract

Exotic options present fund managers with flexibility in constructing a hedge consistent with desired risk and return properties and forward-looking views. However, gaining an understanding of exotic instruments is difficult, particularly since the traditional method of option analysis via payoff profiles cannot be generally applied. One method of analysis that can provide valuable insight is historical performance analysis or backtesting. A flexible utility for the analysis of vanilla-hedged portfolios over specified historical periods has been developed at Peregrine Securities and demonstrated in previous research, but a similar type of analysis for exotic options presents challenges in terms of skew-consistent pricing and time-consuming pricing algorithms. We demonstrate our enhanced backtesting framework through the historical analysis of portfolios hedged with popular path-dependent variations of put spread strategies, namely down-and out and ratchet (or strike resetting) put spreads. These strategies illustrate how exotic options can be used to either increase or decrease risk, and so assist in the construction of the most appropriate hedge.

Keywords: exotic option pricing, derivative portfolio backtesting

JEL Classification: G13, G11, C1

Suggested Citation

Seymour, Anthony and Chikurunhe, Florence and Flint, Emlyn James, Historical Analysis of Exotic Options: A General Framework (March 14, 2013). Peregrine Securities, 2013. Available at SSRN: https://ssrn.com/abstract=2767418 or http://dx.doi.org/10.2139/ssrn.2767418

Anthony Seymour

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Florence Chikurunhe

Peregrine Securities ( email )

21 Main Road
Claremont
Cape Town, Western Cape 7700
South Africa
+27117227551 (Phone)

HOME PAGE: http://www.peregrine.co.za

Emlyn James Flint (Contact Author)

Legae Peresec ( email )

15 Cavendish Street
Claremont
Cape Town, Western Cape 7700
South Africa
27117227556 (Phone)

HOME PAGE: http://www.legaeperesec.co.za

Department of Actuarial Science, University of Cape Town ( email )

Actuarial Science Section, University of Cape Town
Private Bag X3, Rondebosch
Cape Town, Western Cape 7701
South Africa
+27 21 650 2475 (Phone)

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