Vanna-Volga Pricing is a sophisticated options pricing model that accounts for the implied volatility smile or skew observed in market prices. It extends traditional models by incorporating higher-order sensitivities of option prices to changes in volatility and spot price.
Mechanism
This model adjusts the standard Black-Scholes framework by adding terms related to Vanna (the sensitivity of an option’s delta to volatility) and Volga (the sensitivity of an option’s vega to volatility). These adjustments allow for a more accurate valuation of out-of-the-money options, which often exhibit non-Gaussian price distributions.
Methodology
The strategic application of Vanna-Volga pricing in institutional crypto options trading provides more precise valuations and hedging strategies, particularly for complex derivatives. It enables traders to better manage risks associated with non-flat volatility surfaces, leading to more accurate risk assessments and capital allocation in dynamic digital asset options markets.
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