Derivatives -- the View from the Trenches
Derivatives -- the View from the Trenches
Derivatives -- the View from the Trenches
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Theorem 2 and Trading<br />
This tells us that if realised volatility is <strong>the</strong> same as pricing<br />
volatility and if we're gamma short ( VSS<br />
0) and delta neutral<br />
( VS<br />
0) <strong>the</strong>n V<br />
0 and <strong>the</strong>reby<br />
dV VdN E Q [ V ] dt<br />
0<br />
So on a short option book you can sit and collect "jump<br />
premium" and look like an absolute hero -- until a jump<br />
occurs.<br />
This is essentially what is called "picking up pennies in front<br />
of a steam engine" or "<strong>the</strong> trader's option".<br />
No matter how people look at this <strong>the</strong>mselves, this is<br />
essentially <strong>the</strong> strategy that a lot of hedge funds follow.<br />
A couple of spectacular examples:<br />
- The blow up of LOR and portfolio insurance industry in<br />
1987.<br />
- The collapse of CRT in 1987.<br />
- The blow up of LTCM in 1998.<br />
- …<br />
Many of <strong>the</strong>se funds had prominent academics involved, so<br />
following <strong>the</strong> actual disasters we heard a lot of good stories<br />
like<br />
- "19 standard deviation event..."<br />
- "Liquidity squeeze…"<br />
- …<br />
14
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