Long and short dated volatility, Financial Management

Assignment Help:

Q. Long and short dated volatility?

1. If an investor purchase long-dated volatility as well as sells short-dated volatility then the investor is expecting a decrease in the short dated volatility and an increase in the long dated volatility.

Obviously there is no guarantee that these expectations will be realized. If short run volatility goes up or else and long run volatility decreases the pay off from the position would definitely be negative.

This is equal to an investor constructing a short straddle position by using knock-out options. Long straddle may be constructed by utilizing options which have break-out clause to put a limit to unrestricted risk of loss that arises from the short (straddle) position in the short run.

If short dated volatility turns out to be high an additional premium is able to be triggered on the options which are used for the long straddle.

This added payoff from the long volatility position off sets the losses from the short volatility position.

3. The applicable payoff function will shift upwards by the amount of the additional payoff.

4. If the added premium is a fixed amount this may cut potential losses yet it mayn't be sufficient enough. Nevertheless considering that the short position is taken for one month this risk mayn't be a very big risk.

5. It is understandable from the text that volatility positions taken by using the straddles are not pure volatility positions.


Related Discussions:- Long and short dated volatility

What is performance appraisal - cost of capital, What is Performance apprai...

What is Performance appraisal - cost of capital Performance appraisal further, cost of capital framework can be used to evaluate financial performance of top management. I

Determine principal balance at the end of the term, 1. CompuSystems was sup...

1. CompuSystems was supposed to pay a manufacturer $19,000 four month ago and another $14,000 two months from now.  CompuSystems is proposing to pay $10,000 today and the balance i

Evaluation and assessing probability of management risk, Evaluation: On...

Evaluation: Once all the possible events are identified, the next step in the risk management process is to evaluate the events. As stated previously, the evaluation process wo

What are the options available for growth, What are the options available f...

What are the options available for growth Joint venture   A joint venture is when a separate company is formed, in which every member holds an equity st

Explain why accounting profits and cash flows, Explain why accounting profi...

Explain why accounting profits and cash flows are not the same thing. Stock worth depends on future cash flows, their riskiness and their timing.  Profit calculations don't con

Put, Put This is an agreement which is allowing a holder of privacies t...

Put This is an agreement which is allowing a holder of privacies to sell them back to the issuer at a specified amount during a specified time interval. This technique protects

Calculate the total present value of the tax shield, Nortel is considering ...

Nortel is considering the purchase of a new  call routing system.  The system will cost $50M to purchase, an additional $7M to install, and will last for 30 years.  The CCA rate as

Leverage, EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SM...

EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SMALL SCALE COMPANY

Calculation of a firms sales returns, a) The combined two-firm concentratio...

a) The combined two-firm concentration ratio of Motorola (approximately 17.5%) and Nokia (35%) is around 52.5% of the market. b) Up to 2 marks for correct definition: Market sha

Define the basic motivations for a counterparty, Define the basic motivatio...

Define the basic motivations for a counterparty to enter into a currency swap.  Answer:  One major reason for a counterparty to enter into a currency swap is to exploit the comp

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd