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Implied Volatility and Swap Analysis

The chart shows how implied volatility for 5-year EuroStoxx 50 options varies with moneyness, measured as strike price over spot. Implied volatility represents the volatility expected by the market. The curve is U-shaped, with higher volatility for deep in- and out-of-the-money options. In risk-off markets, the curve would shift up as volatility increases across all strike levels.

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Vivek Kumar
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42 views2 pages

Implied Volatility and Swap Analysis

The chart shows how implied volatility for 5-year EuroStoxx 50 options varies with moneyness, measured as strike price over spot. Implied volatility represents the volatility expected by the market. The curve is U-shaped, with higher volatility for deep in- and out-of-the-money options. In risk-off markets, the curve would shift up as volatility increases across all strike levels.

Uploaded by

Vivek Kumar
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

a.

The chart below shows how the implied volatility for a 5 year EuroStoxx 50 option
varies with the moneyness of the option as measured by the strike divided by the spot
price. Explain the term implied volatility, also explain, and critically analyse the shape
of the curve below. How would you expect this curve to change in an environment
when the market becomes more concerned about risk?

EuroStoxx 50 Volatility
20%

19%
Implied Volatility

19%

18%

18%

17%

17%
75% 85% 95% 105% 115% 125%
Moneyness (Strike / Spot Price)

b. Critically analyse the hedging strategy adopted by the trader in part (b) of this question.
In particular you should describe what sources of risk are mitigated by the strategy in
question and what sources of risk remain unmitigated.
c. A trader enters into the swap described in part c as a fixed rate receive with a notional
amount of $10,000,000. The first Libor fixing is set at 2.00%. Immediately afterwards
all interest rates rise by 10 basis point so that the following set of interest rates and
discount factors apply.

Maturity (years) Zero Coupon Interest Rate Discount Factor


0.5 2.10% 0.98961
1.0 2.20% 0.97836
1.5 2.30% 0.96628
2.0 2.45% 0.95247
2.5 2.50% 0.93978
3.0 2.60% 0.92543
3.5 2.65% 0.91198
4.0 2.70% 0.89828
4.5 2.75% 0.88435
5.0 2.80% 0.87020

Determine the change in value of the swap in question; use this to estimate the PV01
sensitivity of the swap and its effective duration.

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