How should I think about VaR for a portfolio that includes options?

Question

AcadiFi · Accepted Answer

For option portfolios, the key question is whether linear approximations are good enough. A pure equity book can often be approximated with returns and weights. An option book may need full revaluation because delta, gamma, vega, theta, and volatility surface changes all affect P/L. Delta neutrality today does not remove nonlinear risk tomorrow.

Suppose Harborline Derivatives owns two stocks and short-dated protective puts. A simple equity VaR based only on stock returns may miss how option values change when volatility jumps or when the underlying moves through a strike. A delta approximation may help for small moves, but a larger stress can require delta-gamma or full repricing.

The FRM answer is to match the method to the instrument. If the options are small and shocks are mild, greek approximations may be acceptable. If the book is materially nonlinear, full revaluation under simulated risk-factor scenarios is safer. The analyst should also define whether volatility is held fixed, shocked, or modeled jointly. Options VaR is not just stock VaR with an extra line item. It is a revaluation problem. On the exam, also state the horizon, confidence level, data source, modeling assumption, and validation step, because those choices usually explain why two reasonable VaR answers differ materially. Practice more in our FRM question bank.

How should I think about VaR for a portfolio that includes options?

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