SurlyTrader’s Book!

After a few years of thought, SurlyTrader has released “Understanding Financial Engineering: Become the Next Quant”. This is a project that has been long in the works with some very slow progress and abandonment at certain times. I thought it was a good idea to write a practical book for anyone getting into my field that contains useful and applicable material in the real world (and is easier to understand). I viewed this as the book that I wish that someone gave me when I started my career. If you know anyone who is interested in getting into quantitative finance, derivatives or what they might call financial engineering – I would like to believe that the book I wrote is a better option than the textbooks currently out there. It will also explain financial engineering to anyone with an interest in how and why derivatives are used.

I have a spreadsheet with full examples (macros, simulations and calculations) that will be sent to anyone buying the book. The kindle version is also available and free for all print owners. The print book is in color which helps read the graphs and charts, so keep that in mind if you have a black & white kindle.

Buy the Book!

The Contents:

Introduction

Chapter 1 – What are Derivatives?

Section 1: Financial Calculation Basics

Chapter 2– Time Value of Money

Chapter 3 – The Yield Curve

Section 2: Basic Derivative Instruments

Chapter 4 – Futures and Forwards

Chapter 5 – Swaps

Chapter 6 – Options

Chapter 7 – Credit Default Swaps

Section 3: Exotic Derivative Instruments

Chapter 8 – Binomial Lattices

Chapter 9 – Monte Carlo Simulations

Chapter 10 – Exotics, CDO’s and Rainbows

Section 4: Lessons Learned the Hard Way

Chapter 11 – Derivative Disasters

Conclusion

Posted in Derivatives, Educational.

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By SurlyTrader – April 16, 2014

Noteworthy News – April 14, 2014

Economy:

The world economy may well be stuck in neutral for years – Telegraph

Wage increases overtake rent rise for first time since 2009 – Telegraph

Occupy was right: capitalism has failed the world – Guardian

Markets:

Stocks Stumble, but Hope Lingers – Wall Street Journal

Why the bulls will be raging ahead – CNBC

Losing Interest – Project Syndicate

How Global Debt of More Than $100 Trillion Is Threatening Your Portfolio – Yahoo! Small Business Advisor

Politics:

UN: ‘Massive shift’ needed on energy – BBC

Why Are Liberal Cities Bad for Blacks? – Bloomberg

Total Taxes on Wages Are Rising – New York Times

Top economists warn Germany that EMU crisis as dangerous as ever – Telegraph

Banks:

The Global Banking Game Is Rigged: The FDIC Is Suing – LA Progressive

The SEC’s just been caught colluding with the banks it’s supposed to regulate – Vox

Greece’s Eurobank gets green light for 2.9 billion euro share issue – Reuters

Posted in Economics, Markets, Media, Politics.

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By SurlyTrader – April 13, 2014

How High Will Vol Go?

One rule that is easy for me to state is that market volatility breeds more market volatility. The question is not whether there is something to worry about, but just how badly you should worry about it. If you look at historical daily stock returns, it is very difficult to find a rule of thumb about “-3% days usually come after +1% for 4 days…” but it is a truth that the past month of market volatility has a predictive power of 65-75% R-squared relative to the next month of market volatility.

After a 30%+ equity return in 2013, everyone should be questioning when the music stops, not if. These same investors should also question just how bad this lack of chairs could get. If you lived through the questioning of 2005/2006, you probably know how much ignorance was embedded in market assumptions. At this point in time you look at the numbers and say that we are too smart (based upon past experience) to let it happen again. The one really dynamic factor that most investors ignore is the marginal dollar of investment that tips the gains/losses in one direction or the other. In the housing bubble in the United States it is (currently) easy to see that easy money going to the housing market bubble was the key factor in the destruction that ensued.

With the slowdown in Chinese (government manufactured) measures of growth, I think it is important to question the dollar amounts in China versus the United States:

None of us will know where the next bubble is directly coming from, but I think it is wise to question every gift before you become complacent.

Posted in Economics, Markets.

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By SurlyTrader – April 10, 2014

Pricing Asian Options

The Asian option payoff depends on the average price of the underlying asset over a specific period of time. The expected payoff of an Asian option is less than the expected payoff of a European option and is therefore much cheaper. On the plus side, the Asian option takes away some of the point of time risks embedded in European options and allow for more stable payoffs.

The payoff of an Asian option simply replaces the expiration price with the average price:

The problem with Asian options (and most exotic options) is that the option price cannot be calculated by simply plugging numbers into the Black-Scholes equation because the payoff depends on the path that the stock price takes until the maturity of the option. The first way to calculate the price is to use a binomial or trinomial tree, but the speed of computers and flexibility of implementation has made monte carlo simulations the more practical method for pricing.

For those of you who are interested in learning how to price an exotic option using Monte Carlo simulations, I have produced an excel spreasheet with modifiable code that is for sale: