Volatility and Correlation - Trading and Risk Management

• General Introduction to Volatility and Correlation
• Modelling and Forecasting Volatility
• Listed and OTC Volatility Products
• Trading and Hedging Volatility
• Modelling and Forecasting Correlation
• OTC Correlation Products
• Trading and Hedging Correlation

The objective of this advanced-level course is to give you a good understanding of state-of-the-art approaches to modelling, pricing, forecasting and trading volatility and correlation.

We start with a general introduction to volatility and correlation, explaining concepts such as realized volatility, implied volatility, stochastic volatility etc., and we discuss their importance for pricing and risk measurement.

Thereafter, we look into how volatility is modelled and forecasted. With real-life market data, we demonstrate how day-to-day and intraday volatility is calculated, and we explain and how these estimates can be smoothed and extrapolated to future time periods using moving averages, exponential moving averages, spline models, and ARMA and GARCH modelling.

We then present and discuss a number of instruments and strategies for volatility trading. These include traditional volatility trading strategies in options, but we also look “variance swaps” and other newer types of instruments. To help us determine current volatility levels relative to historical volatility, we introduce the concept of “volatility cones”, and we show how traders can use this – and other – techniques identify potentially profitable trading opportunities.

Further, we explain how the same instruments and forecasting techniques can be used to hedge portfolios of options and other instruments that are exposed to volatility risk.

We then turn to look at correlation. We present various models for estimating correlation, and we discuss possible problems related to the stability (or lack of stability) of correlation amongst assets. We present and explain a number of strategies for trading correlation, including “dispersion trades”, buying and selling correlation and using OTC covariance swaps.

Finally, we explain how correlation risk can be mitigated using various instruments and techniques.

 

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 General Introduction to Volatility and Correlation

• Why Volatility and Correlation Are Important in Trading and Risk Management?
• Important Volatility and Correlation Concepts
  • Realized Volatility, Implied Volatility, Stochastic Volatility etc.
  • Volatility and Correlation “Smiles”

Modelling and Forecasting Volatility

• Standard Approach to Estimating Volatility
• Moving Averages
  • Simple Moving Average and EWMA
• GARCH Modelling
  • Conditional and Unconditional Variance
  • GARCH (1,1) and Higher Order GARCH
• Implementing GARCH
  • Variance Targeting
  • Maximum Likelihood Methods
• Forecasting Future Volatility
• Volatility Term Structures and Volatility Skews
• Practical Implementation Issues and Pitfalls

12.00 - 13.00 Lunch

13.00 - 16.30 Trading and Hedging Volatility

• The Trading Process
  • Formulating a View on Volatility
  • Setting Trading Goals and Limits
  • Implementation and Follow-Up
• Using Volatility Cones to Determine Current Volatility Levels Relative to Historical Volatility
• Standard Long and Short Volatility Trade Using Options
• Volatility Trading Using Corporate Derivatives
• Setting future re-hedging points: The delta contour map
• Using CBOE VIX Futures and Options
• Using OTC Volatility Products
  • OTC Variance and Volatility Swaps
  • Gamma Swaps and Corridor Variance Swaps
  • Options on Realized Variance
• Trading Volatility without the Use of Options or Swaps
• Volatility Arbitrage
• Hedging Volatility Risk
  • Hedging the “Volatility Book” Using Volatility Swaps, Futures and Options on Volatility
• Small Exercises

Day Two

09.00 - 09.15 Brief recap

09.15 - 12.00 Modelling Correlation

• Types of Correlation Coefficients
  • Pearson's Product-Moment Coefficient
  • Non-Parametric Correlation Coefficients
• Copulas and Correlation
• Estimating Correlation
  • The Need to Reduce Dimensionality in Estimating Correlation
  • The Stability Or Lack of Correlation Amongst Assets
  • Volatility Clustering and Correlations
• Modelling Default Correlation
  • Causes of Default Correlation
  • Market Variables and Data Sources
• Methods for Estimating Default Correlation
  • Moody’s Binomial Expansion Method
  • Asset-Based Approaches
  • Factor Models for Asset Dynamics
  • Modelling Default Correlations with Intensity Models
  • Modelling Dependence Using Copula Functions
  • Backing Out Implied Correlations from Market Data
• Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Trading and Hedging Correlation

• Overview of Ways of Buying and Selling Correlation
• Correlation Related Products
  • OTC covariance swaps
  • Nth-to-default Swaps
  • Index Tranches
  • Leveraged Super-Senior Swaps
  • Constant Principal Protection Insurance
• Dispersion Trades
• Trading Correlation with CDO and Basket CDS Tranches
  • Case Study: CPPI Correlation Trade
• Strategies for Profiting from Correlation “Breakdowns”
• Hedging Correlation Risk
  • Using Currency Baskets to Hedge Currency Correlation Risk
  • Hedging the Correlation Risk in CDO Tranches
  • Delta-Hedging the “Correlation Book”
• Small Exercises

Summary, Evaluation and Termination of the Seminar