In a ten-minute group exercise, pitch a trade on two steel makers: one has options at 28% implied against 35% realised, the other 40% implied against 30% realised. Vega is Rs 12,000 and Rs 9,000 a lot. Build a vega-neutral trade and say what would make it lose.

Buy delta-hedged Lohagad options and sell delta-hedged Kavoor options in a ratio of 3 to 4: 30 lots against 40, Rs 3.6 lakh of vega a point each way, so the book has no net vega. If both implieds move to realised, Lohagad gains 7 points and Kavoor's short gains 10, about Rs 61.2 lakh. It loses if volatility rises in proportion across both names, or if Kavoor's results bring the jump its options are pricing.

Two shops sell the same umbrella, one for less than it has been worth in recent weather, the other for more. You buy from the first and sell to the second, and you do not need to know whether it will rain. Lohagad's options price 28% volatility on a stock that has been moving at 35%, and Kavoor's price 40% on a stock moving at 30%, so the trade buys Lohagad volatility and sells Kavoor volatility and takes no view on which way either stock goes. In a group exercise, say that sentence first and let one person own it; the desk head scores whether the group can state the view before it starts on the numbers. The gap that matters is between implied volatilityThe volatility that, put into an option pricing model, gives the option its market price. It is what the option buyer pays for; realised volatility is what the stock actually delivers. and what each stock has been delivering.

Size on rupees of vega, not on lots. Three Lohagad lots carry 3 times Rs 12,000, Rs 36,000 a point, and four Kavoor lots carry 4 times Rs 9,000, also Rs 36,000, so the trade is built in blocks of 3 bought against 4 sold; ten blocks is 30 Lohagad lots bought and 40 Kavoor lots sold, Rs 3.6 lakh a point on each side. A move of the same number of points in both implieds then leaves the book flat, and what is left is the gap between them, which is the view. Both legs are delta hedged every day so that the stock direction does not decide the result.

Read the table from top to bottom. If implieds move to realised, the long Lohagad leg gains 7 points times Rs 3.6 lakh, Rs 25.2 lakh, and the short Kavoor leg gains 10 points times Rs 3.6 lakh, Rs 36 lakh, Rs 61.2 lakh in all; a parallel 5 point rise costs nothing, which is what vega neutral buys. But volatility in a sector sell-off tends to rise in proportion, not in equal points: a 20% rise takes Lohagad from 28 to 33.6 and Kavoor from 40 to 48, and the short leg loses more than the long leg gains, Rs 8.64 lakh net. The largest risk is the one the data sheet hints at: Kavoor reports in five weeks, and its 40% implied may be pricing that event rather than overpricing calm. If results bring a jump, the short Kavoor leg loses on its implied and on the gap in the stock, which daily delta hedging cannot catch.

Close the way a desk head wants to hear it: the view, the trade, the size, the kill condition. Buy cheap Lohagad volatility, sell rich Kavoor volatility, 3 lots to 4, Rs 3.6 lakh of vega a side; target the 7 and 10 point gaps closing; cut the trade if Kavoor's implied rises 5 points on no news, because that says the market knows something about the results. Two things to concede before being asked: realised volatility is backward looking, so three months at 35% does not promise the next three; and the two legs are short gamma and long gamma in different names, so a large move in Kavoor alone hurts twice, on vega and on gamma. A cleaner version of the idea would use Kavoor options that expire before the results, if they exist, so that the event is out of the trade.