Why is dynamic hedging preferred when implied volatility is high?
Dynamic hedging is the one that does not use options. When implied volatility in option prices is high and your expectation is that the volatility will be less than the implied volatility, you won’t want to be ripped off by options.
Does the curriculum say that? Sounds to me like about the same principle as saying “Well, my life insurance premiums just went up because I took up skydiving. Thus, it’s best for me to cancel my policy”.
pimp missed the second part of the question that’s been posted before. dynamic is better when implied volatility is higher than future expected volatility.
i understand that implied vol is greater, options are more expensive than dynamic hedging… but for Hedging MBS don’t you usually sell options or futures to hedge so you’d want to use options when implied vol is higher?
Its implied in the text. I agree with Joey’s interpretation as well. They both get the job done, but using options is more expensive in a high vol. situation.
For dynamic hedging, the curriculum says it’s a “buy high, sell low” strategy. e.g. since my insurance premiums went up, maybe I should buy more. JoeyDVivre Wrote: ------------------------------------------------------- > Does the curriculum say that? Sounds to me like > about the same principle as saying “Well, my life > insurance premiums just went up because I took up > skydiving. Thus, it’s best for me to cancel my > policy”.
CFAI says as follows: * When the volatility implied in option prices is high and the portfolio manager believes that future realized volatility will be lower than implied volatility, he should hedge dynamically. * When implied volatility is low and the portfolio manager believes that actual future volatility will be higher than implied volatility, he should hedge by purchasing options.
OK. the whole thing your expectation vs markets. if market expects high volatility (and u expect low) then the option prices would be inflated (considering ur expectation)… so thats the issue… but my question is… what is dynamic hedging? I thought it was constantly adjusting the hedge ratio due to change in delta…?
interest rate futures: if you bought them you make money when int rate goes up int rate call options: if you bought them you make money when int rate goes up? is this accurate? if so, i am closing the book on it…
if you expect higher vol you buy futures to extend durtion since mbs have neg convexity and dur will dec as rates decr due to prepmt option embeded but if you expect lower vol than mkt do you buy option instead of sell futures?
turkish_dude Wrote: ------------------------------------------------------- > OK. the whole thing your expectation vs markets. > if market expects high volatility (and u expect > low) then the option prices would be inflated > (considering ur expectation)… so thats the > issue… > > but my question is… what is dynamic hedging? I > thought it was constantly adjusting the hedge > ratio due to change in delta…? Delta? it will be dynamic as well. But this part is from hedging MBS. So adjusting your hedge according to changing duration.