In this post I’m going to wear the risk manager hat, as it seems like a good opportunity to put my FRM certification to use, and share my knowledge of risk management, trade life cycle, and financial markets.

Everyone who trades in financial markets knows that trading involves with risk. Risk is the cost of the chase for returns and yield, and every trader takes some kind of risk when doing so. Obviously this statement didn’t knock you off your seat, but risk management as a whole is much more than what we, as traders, perceive as risk.

As practitioners…

We tend to take many things in trading for granted, and I think that liquidity and price discovery are two things that we rarely think about. Let’s imagine for a second, that we trade E-minis but we can’t see real-time price and when we call our broker, she quotes us 1% bid-ask spread. Obviously we will not be able to trade like that and make money. This is why price discovery is crucial for practitioners in financial markets(no matter whether they are large hedge funds or retail investors).

Liquidity

In normal market conditions we are awash with liquidity. Most liquid assets…

The world of quantitative finance is a fascinating world. The ability to make sense of financial markets using data, math, and statistics is a mind-blowing idea in my opinion. Ever since I discovered the wonderland of derivatives market I knew that my path in the world of trading was going to be the quantitative path (rather than the discretionary path).

The history of modern quantitative finance can be dated back to the early 1900s, with Bachelier’s option pricing model (which was later followed by Black-Scholes option pricing model), but the real evolution of quantitative finance came in the mid 80’s…

Financial markets can be viewed as a cosmic web. Different asset classes/regions are interconnected via the complex system of market microstructure. As such, trying to explain/model the markets behavior using simple methods like stochastic process and normal distribution usually results in a huge surprise when markets exhibit abnormal behavior, and occurrences that are not supposed to happen in our lifetime (based on normal distribution) keep on happening on frequent basis.

One of the most fascinating phenomenon is a Flash Crash. Flash Crash is defined as rapid decline in a security price, followed by a significant price recovery shortly after. In…

Insurance is the bedrock of the financial system. It has existed since the dawn of ages, dated back to 3rd millennia BC in ancient China. Insurance companies have been selling risk for ages, and yet, we rarely hear about an insurance company going under just because there are more insurance claims. So how come insurance companies know how to sell risk (and sell it systematically), while short volatility funds, who practically do the same thing in financial market, blow up quite frequently?

I’ve always had a sweet spot for these “Epic Failures” stories about volatility strategies gone awfully wrong, as…

Any option trader’s first interaction with option pricing was probably quite similar to mine. My first interaction with option pricing was while reading “Option, Futures, and other derivatives” (by John Hull). There it was, this option pricing formula (Black-Scholes) where I could just put few parameters in excel, run few formulas and get an actual price of an option. This was mind-blowing… I felt like I just hit the jackpot, I’m going be a billionaire trading options.. …

Back when I was interviewed for my first job in finance I got a pretty simple assignment (or at least that’s what I thought…). I was given an historical data set of EUR/USD returns (daily closing price/High/Low) and I was supposed to make a decision whether to buy a 1-month volatility based on that.

My first impression was “ok, that’s an easy one, let’s just calculate the historical 1-month close-close volatility and compare that to the implied, and so I did”. At the interview the head of the Quant Research team asked me “what made you use 1-month realized close-close…

As any option trader knows, dynamically hedging option book’s delta exposure is an art as much as it is a science. As assets dynamic follow some kind of Brownian motion (stochastic/random process), we have zero ability to know a priory the terminal dynamic of the underlying, and therefore have no ability to determine the optimal delta hedging frequency (meaning — how often we should offset the delta risk of the option book).

There have been dozens of papers and theoretical works published trying to offer numerical / closed form solution to this question, but at the end of the day…