What is volatility term structure?

The term structure of volatility is the curve depicting the differing implied volatilities of options with the same strike price but different maturities. Intuitively, it reflects the market expectation on the future implied volatility.

How does Delta change with volatility?

Higher volatility increases the delta for out-of-the-money options while decreasing delta for in-the-money options; lower volatility has the opposite effect.

What is volatility matrix?

The volatility surface, or matrix (we will use without any distinction the two terms), is the map of the implied volatilities quoted by the market for plain vanilla options struck at different levels and expiring at different dates.

What is term structure of yield volatility?

The term structure of yield volatility is the relationship between the volatility of bond yields-to-maturity and times-to-maturity. The term structure of bond yields (also called the “term structure of interest rates”) is typically upward sloping.

Why is volatility term structure upward sloping?

The model indicates that a downward sloping volatility term structure corresponds to a potential long disaster, and an upward sloping volatility term structure corresponds to a potential short disaster.

How does volatility trading work?

Volatility trading refers to trading the volatility of a financial instrument rather than trading the price itself. Traders who trade on volatility don’t worry about the direction of price-moves. They’re simply trading the volatility, i.e. how much the price of an instrument will move in the future.

What happens to delta when volatility decreases?

The information presented in this article can be summarized as follows: Higher implied volatility lowers the probability of an ITM strike expiring in-the-money (Delta decreases) Higher implied volatility increases the probability of an OTM strike expiring in-the-money (Delta increases)

Is delta a volatility?

Vega measures the risk of changes in implied volatility or the forward-looking expected volatility of the underlying asset price. While delta measures actual price changes, vega is focused on changes in expectations for future volatility.

How do you construct a volatility surface?

At first glance, constructing a volatility surface looks like a straightforward exercise – identify options that trade on the assets or securities of interest, obtain prices for those options across strikes and expirations, and compute implied vols from those prices. Voila.

What is a volatility cube?

The volatility cube object is an object that takes as input a yield curve, cap volatility matrix, swaption volatility matrix, and, possibly, eurodollar future option (EDFO) prices, and is able to compute a swaption volatility for any given triplet of option tenor, swap tenor, and strike.