Course: Financial Markets, Securities and Derivatives

Assignment
Question number: Task 1 & 2

Student number: 1004993

Programme: MSc. in Financial Forecasting and Investment

02 December, 2010

UNIVERSITY OF GLASGOW
Business School
Task 1

As an option trader working for a hedge fund, a portfolio of BP plc has been selected by
analyzing the recent stock price trends in the market. The company is trading under FSTE 100
and it is a listed company.

Bloomberg trading system is used to select the portfolio and analyze the hedging. From figure 1,
1 it can be noticed that the price volatility of the share is not that much. The maximum price of
the underlying asset is around GBP 655.4 and the minimum value of the underlying asset is
around GBP 302.90 and the average is GBP 497.60. The last three to four months the company’s
stock price has not fluctuated significantly and it has got upward moving curve, thus the portfolio
has been selected.
[Figure 1.1]

It is mentionable that for the assignment, as an option trader I tried to have a call option portfolio
with positive delta and a negative gamma. I focused on the delta as the ratio compares the change
in the price of the underlying asset to the change in the price of a derivative. As gamma can be
used to estimate the price of an option relative to the amount whether it is in the money or out of
the money, I have also focused on that area.
The aim of the report is to have a portfolio that has delta/gamma neutral. In order to establish
such portfolio at the beginning, the following steps have been taken

 Buying in the money call option

 Buying out of the money call option
 Selling near at the money call option

(i) The strategy that is being considered for call option portfolio is most likely to have long
butterfly spread. However, the units that have been selected are not exactly same as long
butterfly spread just to have a better portfolio. Long butterfly spread strategy is chosen as the
maturity date is the 17th of December, 2010. The current stock price of the BP Plc is GBP
428.50. Thus to have long position in the money call option, seven units of call option with lower

2
strike price has been selected that is GBP 400. After that another long position of seven units has
been selected with out of the money call option with strike price of GBP 450. Finally, with nine
units of short position has been taken into account with at the money call option of GBP 430 (as
closest to the current market price) strike price.

From table 1.1, it can be seen that the portfolio states a positive delta of 13422.52 and a gamma
of - 24.47. When buying in the money call option or out of the call option the gamma has
positive value. On the other hand, when selling at the money call option, the gamma is negative
value. As the negative value of at the money call option is higher the both in the money and at
the money call option, the gamma in total becomes negative value.

[Table 1.1]

Contrary to gamma value, delta has positive value as while buying in the money and out of the
money call option the value of delta is much higher value than of at the money call option
negative value while selling it.

[Table 1.2, Graph 1.1]

Table 1.2 represents that on the maturity day (17 December, 2010) before hedging the portfolio
has different payoffs at different price level (between GBP 280 to GBP 603). When the price is
between GBP 280 to GBP 399, the payoff is -1603.3. If the price rises to GBP 416 the payoff
becomes GBP -483.3. From the price level of GBP 433 to GBP 603, payoff tends to have
positive value. However, between the mentioned price levels of the share, there is one breakeven
lies on the payoff line. From the graph 1.1, the payoff line has two breakeven points. One
intersect point of breakeven line and payoff line is between the price level of GBP 416 to GBP
433 and the other one is between GBP 450 to GBP 467.

(ii) As I need to make the portfolio delta/gamma neutral, I will firstly focus on neutralizing
the gamma to hedge my position. To neutralize the gamma, I have used out of the money put
option at strike price of GBP 400. As the gamma is negative and buying put option can give a

3
positive gamma value, I have preferred buying put option. As when the price is lower, the payoff
has negative values it has been focused more on that issues just to reduce the negative payoff.
Another reason to select to buy put option out of the money as it reduces the delta value as it has
negative delta value.

(iii) After neutralizing the gamma, from the table 1.3, it can be noticed that the gamma
becomes -0.01 which is almost zero. Additionally, the delta becomes smaller. The payoff after
gamma hedging is showed in table 1.4. From the graph 1.2 it can be observed that the payoff line
has changed.

[Table 1.3 & 1.4, Graph 1.2]

When the market price is between GBP 280 to GBP 331, the payoff has positive value of GBP
2042.92 to GBP 461.92. If the price drops than GBP 280, there is unlimited payoff. However,
after that when price tends to increase there is sudden drop of payoff and it becomes negative till
the market price is GBP 433. In between the times, it intersects the breakeven line. The lowest
payoff it allows is near about GBP 1800. If the price tends to increase more from GBP 433, there
will be positive payoff. However, this payoff remains positive only for a short time as the payoff
starts to decrease soon and reach to breakeven once again. When the price is more than GBP 450
it again starts to offer positive payoff and reaches to GBP 7672.92 while the share price is GBP
603. The figure 1.2 shows the snapshot of Bloomberg after gamma hedging with the values of
position, strategy and graphs.
[Figure 1.2]

After hedging the delta, with total BP/LN equity, the delta becomes -0.01. As showed in the
table 1.5, the delta of BP LN equity is -11427.24 has made the total porfolio’s delta to reduce to -
0.01.
[Table 1.5]

From the table 1.6 and graph 1.3, it can be seen that when the market price is lower than the
exercise price there is unlimited payoff. However, when the spot price starts to increase the

4
payoff begins to decrease and give downward slopping curve and it intersects the breakeven line
when the price of the share is near about GBP 385. Moreover, the maximum lowest payoff the
portfolio can offer is approximately GBP 1800 when the price is near to GBP 405.

[Table 1.6, Graph 1.3]

While the share price is between GBP 405 to till GBP 440 it has negative payoff. In between the
price level of GBP 433 and GBP 445 there is a peak which offers the payoff of only about GBP
280. If the price is between GBP 440 till GBP 480 it shows negative payoff and a breakeven.
After that the increase in market price starts to offer more payoffs and has upward slopping
payoff lines. A snapshot of Bloomberg is shown to see the whole portfolio scenery after
delta/gamma hedging.
[Figure 4]

5
Task 2

As a portfolio manager, to determine the optimal asset allocation five different companies stocks
have been chosen. The companies are picked from FSTE 100 index after analysis their previous
record of changes in stock prices and current scenario. As a portfolio manager, the portfolio has
been chosen in a way with different kind of companies to diversify the portfolio in industry wise
i.e. one from Tobacco sectors, one from biopharmaceuticals, one from airlines, one from food
and retail and one from beverages. The name of the company that have been selected for
portfolio analysis are as follows:

1. British American Tobacco Plc (BATS.L)-Tobacco Company

2. Astra Zeneca Plc (AZN.L)- Drug Manufacturer
3. British Airways Plc (BAY.L)- Airline Services
4. Associated British Foods (ABF.L)- Foods and Retails
5. Diageo Plc (DGE.L)- Beverages

The points that have been considered to collect the data to get an optimal portfolio are as
followings:
 Current market scenario of the companies
 Earnings history
 Earnings estimates for next two years
 Revenue estimates till 2012
 Growth estimates
 Monthly return

After analyzing the company’s scenario from Yahoo Finance, eight years historical data on
monthly basis from Yahoo Finance starting from January, 2003 to November, 2010 has been
collected. The historical price changes of the companies are showed in graph 2.1.

[Graph 2.1]

6
As one of the important tool for analyzing the data for optimal portfolio, is monthly return of the
companies, it was emphasised more on choosing the company.

 Calculating Stock Returns:

In order to calculate the stock returns of the five mentioned companies, the following formula is
used where SR denotes stock returns, St denotes the price in time t and St-1 denotes the price at
time t-1.

From the graph 2.2, the stock returns of BATS.L for the period of February 2003 to November
2010 are mostly between the negative 10.80% to positive 10.48%. Between the periods the stock
returns shows volatility. However, it’s not that much volatile like other company’s stock.

[Graph 2.2]

It can be observed from graph 2.3 that the stock returns for AZN.L is much more volatile than of
BATS.L as the rate of return it consists of is between negative 17.46% to positive 14.48%.

[Graph 2.3]

Graph 2.4 exhibits that the stock returns of the BAY.L are also very volatile specially between
the period of October 2007 to October 2009. However, it tends to have less volatility after
October 2009. The maximum stock return from the portfolio is 30.61% and minimum stock
returns is negative 40.29%.

[Graph 2.4]

From graph it can be observed that the stock returns for ABF.L the minimum stock returns is
negative 12.74% and maximum value is 13.04%. The fluctuation of stock return is quite higher
for this stock.

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 [Graph 2.5]

The stock return changes of DGE.L are showed in graph 2.6. The fluctuation of stock price is not
like other stocks. The stock’s highest peak is between June 2008 to October 2008 which is about
14.41%.. The minimum stock return is about negative return of 14.20%.

[Graph 2.6]

All the maximum and minimum values are calculated from Excel through data analysis>
Descriptive Statistics which is shown in table 2.2.

[Table 2.2]

 Calculating Monthly Return Mean:

From the table 2.2, it can be observed that the monthly return mean of BATS.L, AZN.L, BAY.L,
ABF.L and DGE.L are respectively 1.49%, 0.41%, 0.88%, 0.78% and 0.66%. The data is
obtained through data analysis>descriptive statistics of the stocks. The monthly return mean can
also be calculated manually through average of stock returns.

 Calculating Standard Deviation:

The standard deviation of the stocks can be found at table 2.2, the way of calculation is as similar
to calculating monthly mean return with data analysis. The standard deviation of the stocks for
BATS.L, AZN.L, BAY.L, ABF.L and DGE.L are .0463, 0.0591, 0.1232, 0.0493 and 0.0411
respectively. To calculate manually, the following formula can be used:

=STDEVP(number1:number2)

8
  Calculating Sample Variance:

From the table 2.2, it can be observed that the sample variance of BATS.L, AZN.L, BAY.L,
ABF.L and DGE.L are correspondingly 0.0021, 0.0035, 0.0152, 0.0024 and 0.0017. The formula
that has been used is as follows

=VARP(number1:number2)

 Calculating Variance –Covariance Matrix:

Table 2.3 Shows the variance and covariance matrix which is calculated by the below mentioned
formula. Here, array shows the monthly stock returns of one stock.

=COVAR(array1, array2)

[Table 2.3]

 Calculating Expected Return:

In order to calculate the expected return, I have used monthly stock return mean.

 Calculating Risk free Rate:

I have assumed the risk free rate is 0.6% as generally risk free rate are much lower than or other
interest rate.

 Calculating Optimal Portfolio:

Using the below mentioned formula, the optimal portfolio is taken into account.

=MMULT(MINVERSE(array1),array1,
array2)/SUM(MMULT(MINVERSE(array1),array1,array2))

9
Here, B118:F122 shows the variance covariance matrix, I117:I121 is the assets return, and K117
is the risk free rate. The optimal asset allocation is showed in Table 2.4

[Table 2.4]

The optimal asset allocation shows that as a the following strategy should be taken:
 For British American Tobacco Plc, long position by 194.85% of BATS.L
 For Astra Zeneca Plc, short position by 40.30% of AZN.L share,
 For British Airways Plc ,long position by 3.45% of BAY.L share.
 For Associated British Foods, long position by 2.00% of ABF.L
 Diageo Plc, short position by 60.00% of DGE.L share

By summing all these weights of taking short and long position, it can be noticed that the
portfolio will have total weights of 100%.

If the above strategy is followed, the portfolio expected return will be 2.39% and portfolio
standard deviation is 8.45% as shown in table 2.5.

[Table 2.5]

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 Table, Figures and Graphs

Table 1.1: Data of before Hedging Portfolio

DeltaNotional
1Day P&L
Strategy

TotCost
Position

Gamma
MktVal
MktPx

Delta
P&L

Rate
Cost
Portfolio
-
of BP/ -19 -18.30 1585.00 13422.52 3132.44 -24.47
1603.30
LN
BP/ LN
0.00 428.50 428.50 0.00 0 0.00 0.00 0.00 0.00 0.00
Equity
BPA LN
12/10 0.00 23.50 24.63 0.00 0 0.00 0.00 0.00 0.00 0.00 0.57
P450
BPA LN
- - -
12/10 -9.00 8.25 8.63 776.70 113 34.20 -742.50 0.57
18731.24 4371.35 160.62
C430
BPA LN
12/10 7.00 2.75 3.00 -210.00 -18 -17.50 192.50 6154.31 1436.25 81.25 0.57
C450
BPA LN
-
12/10 7.00 30.50 31.00 -114 -35.00 2135.00 25999.44 6067.55 54.90 0.57
2170.00
C400

Table 1.2: Payoffs from the Portfolio before Heding

U/Px P&L
280 -1603.3
297 -1603.3
314 -1603.3
331 -1603.3
348 -1603.3
365 -1603.3
382 -1603.3
399 -1603.3
416 -483.3
433 436.7
450 96.7
467 946.7
484 1796.7
501 2646.7
518 3496.7
535 4346.7
552 5196.7
569 6046.7
586 6896.7
603 7746.7

11
Table 1.3: Data of Porfolio after Gamma Hedging

DeltaNotional
1Day P&L
Strategy

Position

TotCost

Gamma
MktVal
MktPx

Delta
P&L

Rate
Cost
Porfolio
- -
of BP/ -11 1658.63 11427.19 2666.79 -0.01
1677.08 18.45
LN
BP/ LN
0.00 428.50 428.50 0.00 0 0.00 0.00 0.00 0.00 0.00
Equity
BPA
LN
3.10 2.375 2.38 -73.78 8 -0.15 73.63 -1995.33 -465.65 24.46 0.57
12/10
P400
BPA
LN - - - -
8.25 8.63 776.70 113 34.20 -742.50 0.57
12/10 9.00 18731.24 4371.35 160.62
C430
BPA
LN -
7.00 2.75 3.00 -210.00 -18 192.50 6154.31 1436.25 81.25 0.57
12/10 17.50
C450
BPA
LN - - -
7.00 30.50 31.00 2135.00 25999.44 6067.55 54.90 0.57
12/10 2170.00 114 35.00
C400

Table 1.4: Payoffs of Portfolio after Gamma Hedging

U/Px P&L
280 2042.92
297 1515.92
314 988.92
331 461.92
348 -65.08
365 -592.08
382 -1119.1
399 -1646.1
416 -557.08
433 362.92
450 22.92
467 872.92
484 1722.92
501 2572.92
518 3422.92
535 4272.92
552 5122.92
569 5972.92
586 6822.92
603 7672.92

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Table 1.5: Data of Porfolio after Delta Hedging

DeltaNotional
1Day P&L
Strategy

Position

TotCost

Gamma
MktVal
MktPx

Delta
P&L

Rate
Cost
Porfolio
-
of BP/ 9750.16 -18 -9768.61 -0.04 -0.01 -0.01
18.45
LN
BP/ LN - - - -
428.50 428.50 11427.24 -7 0.00 0.00
Equity 2666.80 11427.24 11427.24 2666.80
BPA
LN
3.10 2.375 2.38 -73.78 8 -0.15 73.63 -1995.33 -465.65 24.46 0.57
12/10
P400
BPA
LN - - -
-9.00 8.25 8.63 776.70 113 34.20 -742.50 0.57
12/10 18731.24 4371.35 160.62
C430
BPA
LN -
7.00 2.75 3.00 -210.00 -18 192.50 6154.31 1436.25 81.25 0.57
12/10 17.50
C450
BPA
LN - -
7.00 30.50 31.00 -2170.00 2135.00 25999.44 6067.55 54.90 0.57
12/10 114 35.00
C400

Table 1.6: Payoff of Portfolio after Delta Hedging

U/Px P&L
280 6003.12
297 5022.76
314 4042.41
331 3062.05
348 2081.69
365 1101.34
382 120.98
399 -859.37
416 -223.73
433 242.91
450 -550.44
467 -153.8
484 242.85
501 639.49
518 1036.13
535 1432.78
552 1829.42
569 2226.07
586 2622.71
603 3019.35

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Table 2.1 Stock Price and Stock Returns of BATS.L, AZN.L, BAY.L, ABF.L and DGE.L
Dates BATS.L BATS.L AZN.L AZN.L BAY.L BAY.L ABF.L ABF.L DGE.L DGE.L
Monthly prices returns prices returns prices returns prices returns prices prices
01-Jan-03 575 2055.00 114.25 514.00 621.00
03-Feb-03 620 7.53% 2048.00 -0.34% 104.25 -9.16% 507.50 -1.27% 630.00 1.44%
03-Mar-03 591.5 -4.71% 2157.00 5.19% 104.00 -0.24% 493.00 -2.90% 649.00 2.97%
01-Apr-03 600 1.43% 2455.00 12.94% 126.50 19.59% 538.50 8.83% 694.00 6.70%
01-May-03 655.5 8.85% 2473.00 0.73% 140.75 10.67% 572.00 6.04% 655.00 -5.78%
02-Jun-03 687.5 4.77% 2430.00 -1.75% 151.50 7.36% 536.00 -6.50% 647.00 -1.23%
01-Jul-03 634 -8.10% 2483.00 2.16% 172.75 13.13% 533.00 -0.56% 635.50 -1.79%
01-Aug-03 639 0.79% 2430.00 -2.16% 187.00 7.93% 518.00 -2.85% 678.00 6.47%
-
01-Sep-03 646.5 1.17% 2542.00 4.51% 166.25 11.76% 530.00 2.29% 649.50 -4.29%
01-Oct-03 712.5 9.72% 2768.00 8.52% 208.00 22.40% 548.50 3.43% 693.00 6.48%
03-Nov-03 729.5 2.36% 2639.00 -4.77% 228.00 9.18% 568.00 3.49% 725.00 4.51%
01-Dec-03 770 5.40% 2680.00 1.54% 232.50 1.95% 584.00 2.78% 735.00 1.37%
01-Jan-04 765 -0.65% 2602.00 -2.95% 305.00 27.14% 563.00 -3.66% 720.00 -2.06%
02-Feb-04 822 7.19% 2552.00 -1.94% 316.00 3.54% 586.00 4.00% 745.00 3.41%
-
01-Mar-04 818.5 -0.43% 2523.00 -1.14% 276.50 13.35% 618.50 5.40% 709.00 -4.95%
01-Apr-04 855 4.36% 2637.00 4.42% 282.50 2.15% 624.50 0.97% 756.50 6.48%
-
03-May-04 800 -6.65% 2541.00 -3.71% 254.25 10.54% 640.50 2.53% 724.00 -4.39%
01-Jun-04 854.5 6.59% 2474.00 -2.67% 275.50 8.03% 632.50 -1.26% 743.50 2.66%
-
01-Jul-04 836 -2.19% 2461.00 -0.53% 230.75 17.73% 630.00 -0.40% 681.50 -8.71%
02-Aug-04 837.5 0.18% 2555.00 3.75% 224.00 -2.97% 625.50 -0.72% 683.50 0.29%
-
01-Sep-04 801 -4.46% 2265.00 12.05% 207.50 -7.65% 664.00 5.97% 690.00 0.95%
01-Oct-04 820 2.34% 2232.00 -1.47% 215.25 3.67% 695.00 4.56% 728.50 5.43%
01-Nov-04 879 6.95% 2045.00 -8.75% 222.00 3.09% 748.00 7.35% 732.00 0.48%
01-Dec-04 897.5 2.08% 1889.00 -7.94% 235.00 5.69% 780.50 4.25% 743.00 1.49%
03-Jan-05 920 2.48% 1990.00 5.21% 265.75 12.30% 753.50 -3.52% 723.50 -2.66%
01-Feb-05 955 3.73% 2050.00 2.97% 267.50 0.66% 770.00 2.17% 740.50 2.32%
01-Mar-05 933 -2.33% 2086.00 1.74% 264.00 -1.32% 753.00 -2.23% 746.00 0.74%
-
01-Apr-05 978 4.71% 2281.00 8.94% 238.00 10.37% 734.00 -2.56% 774.00 3.68%
02-May-05 1044 6.53% 2335.00 2.34% 274.00 14.09% 800.50 8.67% 790.50 2.11%
01-Jun-05 1076 3.02% 2311.00 -1.03% 263.50 -3.91% 825.50 3.08% 823.00 4.03%
01-Jul-05 1137 5.51% 2558.00 10.15% 277.75 5.27% 858.00 3.86% 786.00 -4.60%
01-Aug-05 1116 -1.86% 2530.00 -1.10% 277.25 -0.18% 845.50 -1.47% 792.00 0.76%
01-Sep-05 1191 6.50% 2635.00 4.07% 292.75 5.44% 822.50 -2.76% 815.00 2.86%
03-Oct-05 1243 4.27% 2533.00 -3.95% 302.00 3.11% 791.50 -3.84% 835.00 2.42%
01-Nov-05 1260 1.36% 2668.00 5.19% 312.00 3.26% 819.00 3.42% 835.00 0.00%

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 Dates BATS.L BATS.L AZN.L AZN.L BAY.L BAY.L ABF.L ABF.L DGE.L DGE.L
Monthly prices returns prices returns prices returns prices returns prices prices
01-Dec-05 1300 3.13% 2829.00 5.86% 334.00 6.81% 839.00 2.41% 842.50 0.89%
02-Jan-06 1267 -2.57% 2722.00 -3.86% 325.75 -2.50% 825.00 -1.68% 836.50 -0.71%
01-Feb-06 1359 7.01% 2635.00 -3.25% 328.75 0.92% 875.00 5.88% 876.00 4.61%
01-Mar-06 1394 2.54% 2900.00 9.58% 353.25 7.19% 848.00 -3.13% 906.50 3.42%
-
03-Apr-06 1402 0.57% 3030.00 4.39% 336.25 -4.93% 761.50 10.76% 905.00 -0.17%
01-May-06 1338 -4.67% 2824.00 -7.04% 340.50 1.26% 739.00 -3.00% 877.00 -3.14%
01-Jun-06 1362 1.78% 3264.00 14.48% 342.75 0.66% 760.50 2.87% 909.50 3.64%
03-Jul-06 1443 5.78% 3269.00 0.15% 387.00 12.14% 840.50 10.00% 941.00 3.40%
01-Aug-06 1440 -0.21% 3404.00 4.05% 410.75 5.96% 829.00 -1.38% 935.00 -0.64%
01-Sep-06 1444 0.28% 3338.00 -1.96% 427.00 3.88% 830.00 0.12% 943.50 0.90%
02-Oct-06 1429 -1.04% 3098.00 -7.46% 459.50 7.34% 832.00 0.24% 970.00 2.77%
01-Nov-06 1439 0.70% 2950.00 -4.90% 492.75 6.99% 847.00 1.79% 976.50 0.67%
01-Dec-06 1429 -0.70% 2744.00 -7.24% 527.50 6.81% 825.50 -2.57% 1002.50 2.63%
01-Jan-07 1544 7.74% 2840.00 3.44% 537.75 1.92% 801.50 -2.95% 990.00 -1.25%
01-Feb-07 1549 0.32% 2864.00 0.84% 536.50 -0.23% 825.00 2.89% 1004.50 1.45%
01-Mar-07 1589 2.55% 2734.00 -4.65% 486.00 -9.89% 864.00 4.62% 1029.50 2.46%
02-Apr-07 1551 -2.42% 2740.00 0.22% 508.50 4.53% 926.50 6.98% 1059.00 2.83%
01-May-07 1711 9.82% 2686.00 -1.99% 470.00 -7.87% 927.50 0.11% 1077.00 1.69%
-
01-Jun-07 1698 -0.76% 2683.00 -0.11% 418.50 11.61% 888.00 -4.35% 1037.00 -3.78%
02-Jul-07 1600 -5.94% 2559.00 -4.73% 397.75 -5.09% 846.50 -4.79% 1012.00 -2.44%
01-Aug-07 1645 2.77% 2445.00 -4.56% 424.25 6.45% 863.50 1.99% 1059.00 4.54%
-
03-Sep-07 1752 6.30% 2449.00 0.16% 383.25 10.16% 800.50 -7.58% 1074.00 1.41%
01-Oct-07 1830 4.36% 2373.00 -3.15% 445.25 14.99% 912.00 13.04% 1100.00 2.39%
-
01-Nov-07 1887 3.07% 2310.00 -2.69% 341.25 26.60% 887.00 -2.78% 1093.00 -0.64%
03-Dec-07 1965 4.05% 2164.00 -6.53% 309.75 -9.68% 899.50 1.40% 1080.00 -1.20%
01-Jan-08 1795 -9.05% 2094.00 -3.29% 332.00 6.94% 866.50 -3.74% 1012.00 -6.50%
- -
01-Feb-08 1895 5.42% 1893.00 10.09% 257.50 25.41% 848.50 -2.10% 1034.00 2.15%
03-Mar-08 1891 -0.21% 1884.00 -0.48% 234.25 -9.46% 875.00 3.08% 1016.00 -1.76%
01-Apr-08 1897 0.32% 2128.00 12.18% 226.50 -3.36% 881.50 0.74% 1033.00 1.66%
01-May-08 1888 -0.48% 2205.00 3.55% 232.50 2.61% 861.50 -2.29% 985.00 -4.76%
-
02-Jun-08 1739 -8.22% 2142.00 -2.90% 215.25 -7.71% 758.50 12.73% 924.00 -6.39%
01-Jul-08 1828 4.99% 2468.00 14.17% 255.25 17.04% 716.50 -5.70% 880.50 -4.82%
01-Aug-08 1861 1.79% 2693.00 8.72% 251.00 -1.68% 806.50 11.83% 1017.00 14.41%
- -
01-Sep-08 1835 -1.41% 2460.00 -9.05% 168.20 40.03% 710.00 12.74% 945.00 -7.34%
-
01-Oct-08 1700 -7.64% 2630.00 6.68% 136.10 21.18% 695.50 -2.06% 951.00 0.63%
03-Nov-08 1698 -0.12% 2445.00 -7.29% 155.10 13.07% 677.00 -2.70% 907.00 -4.74%

15
 Dates BATS.L BATS.L AZN.L AZN.L BAY.L BAY.L ABF.L ABF.L DGE.L DGE.L
Monthly prices returns prices returns prices returns prices returns prices prices
01-Dec-08 1800 5.83% 2807.00 13.81% 179.70 14.72% 730.00 7.54% 961.00 5.78%
-
02-Jan-09 1900 5.41% 2671.00 -4.97% 120.10 40.30% 663.00 -9.63% 944.00 -1.78%
- -
02-Feb-09 1797 -5.57% 2243.00 17.46% 137.20 13.31% 651.00 -1.83% 819.00 14.20%
02-Mar-09 1613 -10.80% 2451.00 8.87% 140.80 2.59% 640.50 -1.63% 786.50 -4.05%
01-Apr-09 1639 1.60% 2385.00 -2.73% 147.90 4.92% 718.00 11.42% 813.00 3.31%
01-May-09 1688 2.95% 2570.00 7.47% 155.50 5.01% 731.00 1.79% 843.00 3.62%
-
01-Jun-09 1673 -0.89% 2677.21 4.09% 124.70 22.07% 762.50 4.22% 871.50 3.32%
01-Jul-09 1858 10.49% 2803.00 4.59% 141.00 12.28% 796.00 4.30% 938.00 7.35%
03-Aug-09 1874 0.86% 2840.00 1.31% 191.50 30.61% 800.50 0.56% 954.00 1.69%
01-Sep-09 1963 4.64% 2818.01 -0.78% 220.50 14.10% 847.00 5.65% 960.00 0.63%
-
01-Oct-09 1943 -1.02% 2742.00 -2.73% 181.80 19.30% 827.50 -2.33% 996.00 3.68%
02-Nov-09 1847 -5.07% 2717.00 -0.92% 195.30 7.16% 805.50 -2.69% 1025.00 2.87%
01-Dec-09 2016.5 8.78% 2910.50 6.88% 186.90 -4.40% 822.00 2.03% 1084.00 5.60%
04-Jan-10 2070.5 2.64% 2912.00 0.05% 206.20 9.83% 883.00 7.16% 1055.00 -2.71%
01-Feb-10 2229.5 7.40% 2883.50 -0.98% 211.20 2.40% 950.00 7.31% 1064.00 0.85%
01-Mar-10 2271.5 1.87% 2939.00 1.91% 243.00 14.03% 978.50 2.96% 1106.00 3.87%
01-Apr-10 2054 -10.07% 2889.00 -1.72% 228.30 -6.24% 1006.00 2.77% 1115.00 0.81%
-
04-May-10 2042.5 -0.56% 2901.50 0.43% 201.20 12.64% 957.00 -4.99% 1055.00 -5.53%
01-Jun-10 2136.5 4.50% 3169.00 8.82% 196.00 -2.62% 974.50 1.81% 1060.00 0.47%
01-Jul-10 2194 2.66% 3238.00 2.15% 219.60 11.37% 1027.00 5.25% 1107.00 4.34%
02-Aug-10 2216 1.00% 3228.00 -0.31% 209.90 -4.52% 1058.00 2.97% 1059.00 -4.43%
01-Sep-10 2374.5 6.91% 3233.50 0.17% 242.80 14.56% 1049.00 -0.85% 1096.00 3.43%
01-Oct-10 2380 0.23% 3129.50 -3.27% 270.70 10.88% 1047.00 -0.19% 1152.00 4.98%
01-Nov-10 2333.5 -1.97% 3023.00 -3.46% 261.20 -3.57% 1067.00 1.89% 1150.00 -0.17%

Table 2.2: Properties of Dataset

Descriptions BATS.L AZN.L BAY.L ABF.L DGE.L

Mean 0.01490164 0.00411 0.0088 0.00777 0.00656
Standard Error 0.00479613 0.00613 0.01278 0.00512 0.00426
Standard Deviation 0.04650018 0.05945 0.12392 0.04963 0.04134
Sample Variance 0.00216227 0.00353 0.01536 0.00246 0.00171
Kurtosis 0.07234171 0.42094 1.67427 0.53045 1.75049
Skewness -0.5099911 0.16592 -0.7986 -0.151 -0.4143
Range 0.21290503 0.31944 0.70909 0.25784 0.28616
Minimum -0.1080228 -0.1746 -0.403 -0.1274 -0.142
Maximum 0.10488222 0.1448 0.30613 0.1304 0.14412

16
Table 2.3: Variance and Covariance Matrix:

BATS.L AZN.L BAY.L ABF.L DGE.L

BATS.L 0.002 0.001 0.001 0.001 0.001
AZN.L 0.001 0.003 0.001 0.000 0.001
BAY.L 0.001 0.001 0.015 0.002 0.001
ABF.L 0.001 0.000 0.002 0.002 0.001
DGE.L 0.001 0.001 0.001 0.001 0.002

Table 2.4: Optimal Portfolio with Risk Free Rate:

Portfolio X (with risk free)

BATS.L 194.85%

AZN.L -40.30%

BAY.L 3.45%

ABF.L 2.00%

DGE.L -60.00%

Table 2.5: Expected Return and Standard Deviation of Optimal Portfolio

Portfolio expected return 2.39%

Portfolio standard deviation 8.45%

17
Graph 1.1: Payoff from the Portfolio before Heding
10000

8000

6000

4000
Payoffs

2000

-2000

-4000
280 297 314 331 348 365 382 399 416 433 450 467 484 501 518 535 552 569 586 603

Price

Payoffs
Graphs 1.2: Payoff from Portfolio after Gamma Hedging
10000

8000

6000

4000
Payoffs

2000

-2000

-4000
280 297 314 331 348 365 382 399 416 433 450 467 484 501 518 535 552 569 586 603

Price

Payoffs

18
Graphs 1.3: Payoff from Portfolio after Delta Hedging
7000
6000
5000
4000
Payoffs

3000
2000
1000
0
-1000
-2000
280 297 314 331 348 365 382 399 416 433 450 467 484 501 518 535 552 569 586 603

Price

Payoffs

Graph 2.1: Historical Price Change

4000

3500

3000

2500
Price

2000

1500

1000

500

0
01-Apr-04

01-May-06

01-Apr-09
01-Nov-03

01-Sep-04
01-Feb-05
01-Jul-05

01-Aug-07

01-Nov-08

01-Sep-09
01-Feb-10
01-Jul-10
01-Dec-05
01-Jan-03
01-Jun-03

01-Oct-06
01-Mar-07

01-Jan-08
01-Jun-08

Month

BATS.L AZN.L BAY.L ABF.L DGE.L

19
 Rate of Return Rate of Return

-15.00%
-10.00%
-5.00%

10.00%
15.00%
20.00%

-20.00%
-15.00%
-10.00%
5.00%

-5.00%
0.00%
10.00%
15.00%

0.00%
01-Feb-03 01-Feb-03 5.00%
01-Jul-03 01-Jul-03
01-Dec-03 01-Dec-03
01-May-04 01-May-04
01-Oct-04 01-Oct-04
01-Mar-05 01-Mar-05
01-Aug-05 01-Aug-05
01-Jan-06 01-Jan-06
01-Jun-06 01-Jun-06

AZN.L
BATS.L

Graph 2.3: Changes in Stock Return of AZN.L

01-Nov-06 01-Nov-06
Graph 2.2: Changes in Stock Return of BATS.L

Month
01-Apr-07 Month 01-Apr-07
01-Sep-07 01-Sep-07
01-Feb-08 01-Feb-08
01-Jul-08 01-Jul-08
01-Dec-08 01-Dec-08
01-May-09 01-May-09
01-Oct-09 01-Oct-09
01-Mar-10 01-Mar-10
01-Aug-10 01-Aug-10

20
 Rate of Return
Rate of Return

10.00%
20.00%
30.00%
40.00%

-50.00%
-40.00%
-30.00%
-20.00%
-10.00%
0.00%

0.00%
5.00%
10.00%
15.00%

-15.00%
-10.00%
-5.00%
01-Feb-03
01-Feb-03
01-Jul-03
01-Jul-03
01-Dec-03
01-Dec-03
01-May-04
01-May-04
01-Oct-04
01-Oct-04
01-Mar-05
01-Mar-05
01-Aug-05
01-Aug-05
01-Jan-06
01-Jan-06
01-Jun-06

ABF.L
BAY.L
01-Jun-06

Graph 2.5: Changes in Stock Return of ABF.L

Graph 2.4: Changes in Stock Return of BAY.L

01-Nov-06
01-Nov-06

Month
01-Apr-07

Month
01-Apr-07
01-Sep-07
01-Sep-07
01-Feb-08
01-Feb-08
01-Jul-08
01-Jul-08
01-Dec-08
01-Dec-08
01-May-09
01-May-09
01-Oct-09
01-Oct-09
01-Mar-10
01-Mar-10
01-Aug-10
01-Aug-10

21
 Rate of Return

0.00%
5.00%
10.00%
15.00%
20.00%

-20.00%
-15.00%
-10.00%
-5.00%
01-Feb-03
01-Jul-03
01-Dec-03
01-May-04
01-Oct-04
01-Mar-05
01-Aug-05
01-Jan-06

DGE.L
01-Jun-06
Graph 2.6: Changes in Stock Return of DGE.L

01-Nov-06

Month
01-Apr-07
01-Sep-07
01-Feb-08
01-Jul-08
01-Dec-08
01-May-09
01-Oct-09
01-Mar-10
01-Aug-10

22
Figure 1: Current Price Change Scenario of BP.L

Sources: Bllomberg Trading system 30 November, 2010

Figure 2: Payoff of Portfolio before Hedging

Sources: Bllomberg Trading system 30 November, 2010

23
Figure 3: Payoff after Gamma Hedging

Sources: Bllomberg Trading system 30 November, 2010

Figure 4: Payoff after Gamma and Delta Hedging

Sources: Bllomberg Trading system 30 November, 2010

24