IRTG1792DP2021 021
Hedging Cryptocurrency Options
Jovanka Matic
Natalie Packham
Wolfgang Karl Härdle
Abstract:
The cryptocurrency (CC) market is volatile, non-stationary and noncontinuous.
Together with liquid derivatives markets, this poses a unique opportunity to
study risk management, especially the hedging of options, in a turbulent market.
We study the hedge behaviour and effectiveness for the class of a ne jump
diffusion models and infinite activity Lévy processes. First, market data is
calibrated to SVI-implied volatility surfaces to price options. To cover a wide
range of market dynamics, we generate Monte Carlo price paths using an SVCJ
model (stochastic volatility with correlated jumps) assumption and a close-to-
actual-market GARCH- filtered kernel density estimation. In these two markets,
options are dynamically hedged with Delta, Delta-Gamma, Delta-Vega and Minimum
Variance strategies. Including a wide range of market models allows to
understand the trade-off in the hedge performance between complete, but overly
parsimonious models, and more complex, but incomplete models. The calibration
results reveal a strong indication for stochastic volatility, low jump frequency
and evidence of infinite activity. Short-dated options are less sensitive to
volatility or Gamma hedges. For longer-date options, good tail risk reduction is
consistently achieved with multiple-instrument hedges. This is persistently
accomplished with complete market models with stochastic volatility.
JEL Classification:
C00