[Ffts-develop] Vol surface manipulation

[Mark H. <mgh...@ya...>]

Right now in the FFTS, all you can do is view the implied vol
surface (with the vol surface viewer). It'd be nice to be able
to manipulate the vol surface, but we need some small-parameter
way of specifying it.

I'm thinking of parameterizing the vols for a given tenor by ATM
vol, "smile", and "skew", where ATM == forward price, and smile
and skew are defined (for a given tenor) as:

u = European call Delta - ATM European call Delta
Vol( u ) = ATM Vol + skew * u + smile * u^2 + offset( u )

and choosing skew & smile to minimize the sum of offset(u)'s
squared for the options that trade in the market.

Does anyone reading this have practical experience in the equity
derivatives market - how do they specify the vol surface? In
strike space or in Delta space? 

Delta space (as above) seems more theoretically pleasing, but
strike space lines up with how the options trade, so it's not
clear to me.

Perhaps a simpler scheme than the one above is better, since
that's fairly numerically intensive. Any ideas?

Doing this sort of small-parameter fit will help not only for
playing with the market state so see how it affects your risk,
but also because it might give some insight into how the markets
work and lead to improved modeling. This has certainly been true
in the FX vol market, so I suspect building intuition here can
go a long way as well.




=====
-------------------------------------------------------
Mark Higgins, mgh...@ya...
http://www.molala.net

Opinions expressed herein do not reflect my own views;
I haven't had free will since last year when aliens ate
my brain.

__________________________________________________
Do You Yahoo!?
Find a job, post your resume.
http://careers.yahoo.com