Why using "Basis Point Volatility" is better than "Relative Rate Volatility"?

Discussion in 'Options' started by OddTrader, Aug 8, 2009.

  1. Well, to be honest, I have never seen anyone in the rates world calculating PNL in %age terms (but then again, I have never traded yen; still, I believe that even in yen, it's all about the basis points).

    As a result, I have never seen anyone look at lognormal vol charts. However, given the brave new world of 0% rates across the globe, it is worthwhile.

    So, I suppose, the answer to your question is that your assessment of a given trade would depend on your view of the current vol regime. If rates are low, you may conclude that the world is largely lognormal and pay more attention to Black prices/vols. Otherwise, the world is normal, in which case normal makes a lot more sense.
     
    #11     Sep 23, 2009
  2. someone who knows what he is talking about, glad to see that!!!

    To the others: If you express interest in learning about the pros and cons of each interest model then I recommend the paper by Marc Henrard "Swaptions: One price, ten deltas". Also Pat Hagan's paper on SABR is a good starting point!!!


     
    #12     Sep 23, 2009
  3. tray_dar

    tray_dar

    Believe me it does happen in dollar/euro/sterling and not just yen!

    Say the market was normalised and I want to put on a normalised strategy - is it possible to workaround this for lognormal pnl? For e.g. what I don't gain in black vega i would make some of it on the delta etc....or does it simply not work.

    Also, are complex equity vol strategies applicable to the rates world? I sense that only fairly basic strategies are used in swaptions e.g straddles, strangles, payer/receiver spreads etc but rarely multiple combinations as discussed on this forum....
     
    #13     Sep 23, 2009
  4. Every bb has a pedantic pinhead poster who asks for info about obscure topics he searches for in books, white papers, etc.
     
    #14     Sep 23, 2009
  5. I don't know, dude... I only speak based on my own, personal, first-hand experience. In the world of rates, I have never seen anyone look at their pnl in %ages (maybe real money people do).

    Yes, indeed, you can always work around the normal/lognormal issues in a reasonably simple manner (it just involves looking at converting the various partials; for a good treatment of this you can look at Marc Henrard's paper that asiaprop mentioned). Problem is that for any OTM options all these methods, even the more sophisticated ones, degrade quite badly. Then all your risk factor pnl attribution starts going screwy.

    You're right that in the world of rates things normally don't get too exotic. Simple reason for this, in my view, is bid/offer. The wondrous multi-leg monsters you could do in equity options quickly start looking very ugly once you realize how far from mid you're likely to get anything done. Besides, I personally never understood the reason for doing these monster trades in equities/indices in the first place.

    asiaprop: yes, indeed... The Henrard piece and the "Managing Smile Risk" by Pat Hagan are the seminal SABR papers. There's also a few more recent corrections to the model. You can see many threads on this on Wilmott or Nuclear Phynance.
     
    #15     Sep 23, 2009
  6. yeah, I try to keep up with the changes to SABR (dynamic SABR, calibration issue) but I moved long time ago to the equity and fx space where SABR is rarely used. Just remembered the good ol times ;-)
    Wilmott is a great forum for mostly rates geeks, they really know their stuff.

     
    #16     Sep 23, 2009
  7. Yep... As I understand it, SABR does get used occasionally in the equity world, but has its own unique set of issues there.
     
    #17     Sep 24, 2009
  8. I have seen some guys using it at fx trading desks but it does not even seem to be used to price contracts such as standard one-touchs. I see it as being a lot more applicable to exotic fixed income and fx products, such as range accruals or PRDCs.

    Anyway, back to trading (rather than pricing): Treasuries seem to be well bid after the FOMC announcement. Interesting to see whats gonna eventually happen when the slightest hint of inflation will linger around. My bet is the Fed will again be behind the curve on that one, but it may take many months/2-3 years till we see that. For now this steepness seems to invite healthy bids in the 10year.

    On the equity front I play the short side for the first time in many weeks. Shorted S&P 1080 calls expiring Sep30 and Oct16.


     
    #18     Sep 24, 2009
  9. I don't know, dude...

    I am very confused now, torn in all sorts of directions. FWIW, I'd still be long spooz here. I don't think the inventory rebuild story has yet run its course completely, so I think we'll be hearing more bullish stories yet. The only way I can explain the bid for nominal FI against this backdrop is simply that there's so much previously sidelined money that's being pumped into all and any assets.

    At any rate, maybe this is the wrong forum for this discussion.
     
    #19     Sep 24, 2009
  10. lol, true point (your last comment).

    back to bpvol...;-)


     
    #20     Sep 24, 2009