Abcs option volatility trading strategies pdf download
Optionality also occurs in products that you would not normally associate with options. Traders use an option pricing model, Black modelto price these options. Suppose Libor fixed at 3. Gamma refers to the rate of change of the delta. A deep in the money option has a delta approximating at 1.
The bank needs to cancel part of the swap. If the underlying price remained relatively static the trader would lose both option premium payments. Let's suppose you want to independently value the option positions that a trader has. The lower the underlying price at expiry the greater the potential loss for the put option seller.
If the bond price increases the delta increases, if it falls the delta declines. Passing this cost on the customer is not always straight forward. Gamma refers to the rate of change of the delta. Another way to reduce the premium payment is to use combinations of options. If the underlying price remained relatively static the trader would lose both option premium payments.
You obtain the appropriate option pricing model, input the relevant information but what implied volatility do you use? The trader must continually rebalance the hedge to reflect the change in the delta. However many trades in the over-the-counter market may not be identical in structure to those quoted by banks or brokers.
The option will be related to a specific bond known as the underlying. There are two types of swaption. Rising forward rates will increase the price of the cap, falling forward rates will decrease the cost.
Gamma refers to the rate of change of the delta. The owner of a put option has the right to sell, but not the obligation to sell. The dealer is short the cap and long the floor.
There are two types of volatility that we could use in order to price options. If this rate is lower than the strike the seller of the floor pays the buyer a sum of money. A floor is therefore not one option but a string of individual options known as "floorlets" on forward Libor rates.
If not an arbitrage opportunity exists. In this sense "fair value" can be determined be reference to quoted market prices. The higher the underlying price the greater the profit.
A deeply OTM has a delta approaching zero, see diagram below. For an option trader this is important. This FRN contains a cap and a floor, these are options on Libor.