Choosing Hedge Ratios for Relative-Value Trades in American Options on Futures

Summary

The document frames a relative-value trade between American-style options on different futures, potentially quoted in different currencies. The proposed view is to sell volatility in the option with higher implied volatility and buy volatility in the other, using at-the-money straddles, then determine how many contracts of the second leg offset one contract of the first.

It identifies theta-, vega-, and dollar-gamma-weighted approaches as candidate hedge-ratio methods and asks for worked examples and references. However, it supplies no calculation, market data, answer, or supporting study, so it does not establish which weighting is appropriate. In practice, the ratio depends on the chosen exposure to neutralize, contract multipliers, currency conversion, option sensitivities, and the behavior of American exercise features; the document leaves these details unresolved.

Key ideas

• The proposed trade sells the higher implied-volatility straddle and buys a lower-volatility straddle on another futures contract.
• Theta, vega, and dollar gamma are suggested as alternative bases for sizing the spread legs.
• The document asks for a contract ratio but provides no worked calculation or answer.
• Different currencies, contract specifications, and American exercise features affect how the legs should be compared.

Tags

# Relative Value Trading of American Style Options on Futures, Calcuating hedging ratios?


# Relative Value Trading of American Style Options on Futures, Calcuating hedging ratios?












I am interested in Relative Value Trading of American style options on futures and have not found a whole lot of literature on it. The best resource I have discovered so far is a few pages in Colin Bennett's Trading Volatility, which is about equities. He mentions 3 methods: Theta Weighted, Vega-weighted, and dollar gamma-weighted. However no workable examples.

For 2 American options of the same expiry, but different underlying futures contracts which may be in different currencies. How would you go about determining the hedging ratio between the two legs of a spread?

For example: If A has higher implied vol then B on a similar underlying (a commodity future in different currencies), I would like to short A's Volatility and Long B's Volatility. Lets assume we are using ATM straddles. For every 1 contract of A I want to be short, i should buy X contracts of B.

What is X?

Can I have any worked examples of the Theta/Vega/Dollar Gamma type weightings?

Point me to any papers or other resources regarding this topic. Everything is appreciated. Thank you

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