Choosing a Volatility Surface Rule for Underlying Shocks

Summary

The document raises a risk-management question for a market maker in liquid, short-dated vanilla options: how to estimate portfolio Greek changes after large moves in the underlying. The starting volatility curve is built from current implied volatilities by strike and lightly smoothed. The trader asks how to shift that curve when the underlying moves, beyond applying a separate volatility shock.

It identifies sticky delta as a candidate: under that convention, options at a given delta retain their volatility as the underlying changes. The document does not provide a worked calculation, compare sticky delta with alternatives such as sticky strike, or establish which rule best describes actual market behavior. It is therefore a question about scenario assumptions rather than evidence for a particular forecasting method. Any risk report built from it would need to make the chosen surface rule explicit and recognize that large-move results depend on that assumption.

Key ideas

• Sticky delta keeps implied volatility fixed for options at the same delta as the underlying moves.
• The question concerns repricing a strike-based volatility curve after large underlying shocks.
• The proposed use is to estimate how a vanilla options portfolio's Greeks may change under stress.
• The document proposes sticky delta but does not validate it against market data or compare alternatives.

Tags

# Vol surface changes as underlying moves


# Vol surface changes as underlying moves












We market make in highly liquid, near term options markets. I want to build a risk report that tells us how our portfolio's greeks will change as the underlying moves. This is for risk management in the face of unusually large moves, such as 2, 5 and 10% moves in the underlying. We are only trading vanilla options.

My starting vol curve takes IVs from the current market at every strike and lightly smooths them. I want to 'shock' the underlying & the vol curve in several different directions. Obviously, it is easy to shock vol up by 30% of current vol, but how do I predict how the curve moves when I shock the underlying up 5%?

Given that I am modeling large moves, I'm leaning towards using the "sticky delta" approach where the options with a given delta keep their volatility.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.