Delta Hedge Backtesting (Equity-PUTS)

Delta Hedge Backtesting (Equity-CALLS)

Delta Hedging Simulation (Equity)

The criteria for this simulation requires that I find a mispriced option contract due to my interpretation of what the implied volatility should be.  In order to forecast volatility I will use my experience with fluctuating premiums and directional moves to calculate an assumed future volatility.

I plan on buying the option and selling the underlying so for the model I have to find a stock, determine an expiration date, assume an interest rate, and define an adjustment interval to balance the fluctuating deltas.  Since this example is based on equity which is subject to stock-type settlement, the interest rate will be used to calculate only the carrying costs for the initial outlay.  If futures were used then the fluctuation of cash as a result of the MTM treatment would debit or credit variation costs calculated with the interest rate.

CME is a good candidate for this simulation because it historically has had rapid price movement due to political fundamentals relating to legislation which if passed would require OTC swaps to be cleared through a credible exchange.  The two leading candidates for this are CME and ICE.

Backtesting of this strategy can be found in the following links:
Link to CME 2010 Backtesting CALLS
Link to CME 2010 Backtesting PUTS

Stock CME Closed at 310.84 on 1/11/11
Strike 310
Expiration Mar-11 66 days from 1/11/11
Impl Vol 26.95%
Forecast Vol 31% 3/18/11
Delta 0.52 1/11/11
Interest Rate 8% Theoretical
Adj Interval Weekly

Buy 10 CME MAR 11 310 CALLS @ 14.60
Sell 520 shares CME @ 310.84

Risk profile of position

Week Stock Price Delta Tot Delta Pos Adj Tot Adj
0 310.84 0.52 0 0 0

The forecast volatility of 31% will stay constant throughout the simulation.  With a volatility of 31% the premium of the MAR 11 CALLS is 18.04.  At the current levels the volatility implies 15.47.