Total return swaps

Defintions A total rate of return swap is a fixed for floating swap in which cash flows are exchanged but the floating rate on one side is based on the total rate of rate of…

Caps and floors in a risk free rate (RFR) world

Definition An interest rate cap is an option structure whereby the buyer is protected against rates rising above a pre-agreed level – the option’s strike.  A floor gives the buyer protection against rates falling below…

Understanding theta

Introduction In some previous posts I had explained the concept of delta and gamma within an option trading context.  One of the strategies we analyzed was a delta-hedged short call position. This position has characteristics…

Understanding gamma – part 4

This is the fourth post in a series looking at elements of option trading and option risk management. In the earlier posts (part 1, part 2, part 3) on this subject we defined gamma as…

Understanding gamma – part 3

In the previous posts we had looked at a delta hedged short call position, which we argued was a way of expressing a view on ‘large’ movements in spot and changes in implied volatility.  Here…

Understanding gamma – part 2

Gamma is defined as the rate of change of delta with respect to a given change in the underlying price.  In the last post we looked at delta hedging a short call position and looked…

Understanding gamma – part 1

Introduction Over the last few posts we have spent a fair amount of time looking at delta as a measure of directional price risk.  Arguably, the more difficult concept to grasp is that of gamma. …

Option risk management part 3: Delta hedging

Let’s start with a quick recap of a couple of key concepts.  Suppose you have bought a 3 month ATM option on Tesla struck at a price of $1,000.  With an implied volatility of 60%…