Assume Nick Lesson, on December 15th, 1994, knowing that he was in trouble, and having perfect foresight, instead of doubling down and selling options, devised a strategy to offset his long exposure of 20,000 futures contracts…He was already down 208mm pounds and wanted to break even by the end of Q1 1995.
a.) Come up with a strategy that would have allowed him to be back to zero by end of Q1.
-Calculate the cost (or collect) of entering the strategy
-The effect on margin (if any)
-Number of contracts
-Graph the PnL of the Perfect Foresight strategy
b.) Let’s say Nick Leeson had employed a different index arbitrage strategy. Using the historical prices from the Hang Seng and the Nikkei 225, use a one week return convergence rule to try profit from return deviations. Use the Jan 1996 to Dec 2005 period as the estimation window for the daily mean and standard deviation calculations, and use Jan 2007 through Dec 2016 for the investment period analysis (use overlapping windows). Invest when the daily return discrepancies are 1 standard deviation away from the mean.
The investment will be:
When Hang Seng Return-Nikkei 225 Return>1 stdev from mean
Hang Seng =Protective Put
Nikkei =Sell a Put/ Short Index
Hang Seng Return-Nikkei 225 Return<1 stdev from mean
Hang Seng = Sell a Put/ Short Index
Nikkei = Protective Put
Assume each time is an investment opportunity there is an ATM option with 22-days to maturity and use the EWMA volatility. Also assume a RFR of 3% for all options.
Your initial portfolio is $1mm. Each option investment will invest in 1 combined position (size will be 100). The rest of the capital earns interest at the RFR. Calculate your final portfolio value on Dec 30th 2016 and graph the time-series of the portfolio value. (10 points)
c.) How would Nick Leeson have reported the Quarterly PnL of this strategy given the Baring’s setup in Singapore (5 points)?
2c.) Qualitative answer
