Single Stock and Custom Basket Options in Fund Management

Peregrine Securities, 2014

28 Pages Posted: 22 Apr 2016

See all articles by Anthony Seymour

Anthony Seymour

University of Cape Town (UCT)

Emlyn James Flint

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

Florence Chikurunhe

Peregrine Securities

Date Written: February 14, 2014

Abstract

This report provides an overview of the utility of single stock and custom basket options in fund management. It is shown that managers of active equity funds can limit possible negative return contributions of their over - and underweight positions via single stock options and thus help to hedge against underperformance of the fund relative to the benchmark.

We highlight the fact that non-index equity portfolios are imperfectly hedged by index derivatives. In this context we describe an analysis that helps to quantify the risk associated with a portfolio-underlying mismatch, and discuss how this risk can be addressed via an option or future on a custom basket of stocks.

We also discuss challenges in pricing single stock options and provide an overview of a single stock volatility skew calibration system developed at Peregrine Securities that addresses an important need for accurate volatility estimates. Using these single stock volatility skews, we are able to implement a simple procedure for the calculation of implied volatility for options on custom baskets.

Keywords: implied volatility calibration, single stock option pricing, basket option pricing, portfolio hedging

JEL Classification: C14, C15, C4, C61, G13

Suggested Citation

Seymour, Anthony and Flint, Emlyn James and Chikurunhe, Florence, Single Stock and Custom Basket Options in Fund Management (February 14, 2014). Peregrine Securities, 2014. Available at SSRN: https://ssrn.com/abstract=2767424 or http://dx.doi.org/10.2139/ssrn.2767424

Anthony Seymour

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

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)

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

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