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From: Srihari Angara
Affiliation:
Address: sriangara@ureach.com
Date: 05 Feb 2004
Time: 22:30:52
I wonder if there is any model or methodology to measure risk in these highly structured OTC options. The name is a misnomer as no swap is involved except to define the calculation method and valuation of the option. Briefly, this is an offshoot of credit derivatives, where in Party A sells the CB to Party B with an option to buy it back if certain strike price is reached before the expiry. The option premium is built into the CB purchase price.The Party A hedges the long option position by going short on the underlying equity of the issuer. I am thinking that the best approach is to treat them as long equity options against short equity but that is not 100% accurate as CB has both bond and stock component in it with interest rate floor and stock vols affecting the option price. Any suggestions or anybody knows what shop is trading these instruments. I know UBS and Lehman are the ones doing them in limited number .. but I do not know if these are liquid and what risks we should be aware of and whether VaR calculation is possible. I appreciate your feedback, Srihari
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