← InstitutionalLesson 2 · 4:06
How does the whole surface move when the market moves?
Summary
You can read a volatility surface along a row (the skew) and down a column (the term structure). You can describe sticky strike, sticky delta and local volatility as three models of how the surface moves when the index moves, and explain why each gives a different hedge for the same option.
Key terms
- volatility surface
- Implied volatility drawn for every strike and every expiry at once, with strike across, expiry going back and volatility as the height.
- skew
- The tilt of implied volatility across strikes, one volatility for each strike, usually rising toward the far puts.
- term structure
- At-the-money implied volatility drawn across expiries, from near to far.
- sticky strike
- A model where each strike keeps its volatility as the index moves, so the skew line stays still.
- sticky delta
- A model where the whole skew line slides with the index, so options the same distance away keep their volatility.
- local volatility
- A model whose rule of thumb near the money is that every strike's volatility rises by the slope of the skew as the index falls, so the whole line lifts.
Check yourself
Answer each question to see why the right answer is right.
1. On the real SPX surface, you walk along the December row from low strikes to high strikes. What are you reading?
2. The index falls 3%, from about 7,541 to about 7,315. Under sticky strike, what happens to at-the-money volatility on the December row?
3. Under sticky delta, after the same 3% fall, what happens to the volatility of the December 7,550 call?
4. The three pictures give the December 7,550 call deltas of 0.51, 0.63 and 0.38. Why does sticky delta give the highest number?
5. Two desks hedge the same December 7,550 call, one using sticky delta and one using local volatility. On a 1% move, about 75 index points, their hedges differ by about $1,869 a contract. What does the lesson say a desk should take from this?
Finished the video and the quiz? .