Volga Risk refers to a specific risk measure in options trading, particularly relevant for exotic options or those with complex dependencies, which quantifies the sensitivity of an option’s price to changes in the skew of implied volatilities across different strike prices. It measures how the option value changes when the “smile” or “smirk” of the volatility surface alters its shape.
Mechanism
The mechanism for calculating Volga Risk involves a second-order derivative, specifically the cross-derivative of an option’s value with respect to implied volatility and the skew parameter of the volatility surface. This necessitates a robust volatility surface model that accurately captures the non-linear relationship between strike prices, time to expiration, and implied volatility.
Methodology
Traders and risk managers use Volga Risk to assess exposure to shifts in the shape of the volatility surface, especially when trading complex options or managing a portfolio of derivatives. Understanding this risk is critical for institutional options trading desks in crypto, where volatility surfaces can be less stable and more pronounced than in traditional markets, informing hedging strategies and capital allocation decisions.
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