this is about reading 18 example 6, question 3, can someone tell me what a long 25 delta seagull actually mean? and why does this provide an unlimited upside with an ATM put, because if you short it then you can still enjoy the upside?
I think i am confused about this whole concept in general, upside would be the ZAR/GBP goes down since you have a long ZAR exposure…can someone help me sort this out
This is a sneaky question and if you’re not great with currency will drive you bonkers. I’m NOT good with currency so it took me few minutes to think it through.
I prefer the currency we are long being in the base but they flipped it here so everything is the opposite. We are long the ZAR in the numerator so how do we protect against the downside, or the risk the GBP appreciates (ZAR depreciates)? We BUY a ATM put which is expensive. This because we are purchasing the RIGHT TO SELL the ZAR in the case it depreciates. The ZAR depreciates if the numerator goes up. How do we offset some of that cost? We SELL the OBLIGATION to sell someone else the ZAR in the case it appreciates or the numerator goes down. Now how do we get this unlimited upside they mention. Well, the upside is being able sell the ZAR if the GBP appreciates or said another way numerator goes up, which in theory is infinite. We can buy another OTM 25 delta put on the ZAR giving us the right to sell the ZAR, buy GBP and reconvert back to the ZAR. That’s how I rationalize it…
In the classic seagull spread(short seagull position) we have a cap because of the short call and not a floor because when the short put get ITM we lose the hedge.In the example you mention it says that is a long seagull spread so we have the inverse profit graph with a floor because of the long call and ‘unlimited’ upside potential we are short S long OTM put short ATM put max gain must be at S=0.i hope that’s correct 