Modelling Skew

Discussion in 'Options' started by Profitaker, Sep 14, 2005.

  1. Where the volatility smile for any particular option month is known, how, or using what formula, is the option price change <i>solely</i> attributable to Vol smile (skew risk) calculated ?

    I know you could manually enter the changing IV into the BS model, but is there a less tedious way of incorporating this phenomena into the model ?
  2. gbos


    For moderate skew and kurtosis values you can try the Corrado-Su model. See attached excel file.

  3. It's easy to implement in excel. Simply run any model assuming a flat vol-surface and run a column with an +/- fairval using atm implied as model vol. It's made more difficult when attempting to model vol-convexity since sticky stike and delta models are worthless.
  4. That looks really useful, thanks. Welding it into the BS model though might prove quite challenging - I can see lots of circular references cropping up. Unless of course, you've prepared one earlier ?

    Yes, it's precisely the convexity I'm having trouble with. Think that model from gbos just might work.

  5. It's not ideal as it's a sticky-skew model, but I can't reference anything better.
  6. Sure, but I think I could change the "strike" input of the Corrado-Su model to that of the underlying (fed from a dde link), so that the vol smile would actually move in line with underlying movement, rather than stick.

    Don't know, early days yet. How do you account for it ?
  7. I use a flat-surface and model the variance at 25d. It's more important to me to know the over/under fairval figure.
  8. 25d ?
  9. 25deltas -- the wire services use the 25delta fig in their risk-reversal calculations.
  10. Thanks. Do you use some sort of formula to re-calculate option value using the new IV, or do you input it manually into the model ?
    #10     Sep 14, 2005