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boulala666
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Joined: February 9th, 2015, 10:31 am

Risk Reversal and Butterfly in Forex Markets

March 20th, 2015, 7:43 am

Hi there,can someone explain to me why the Risk Reversal measure the Skew of the Smile Curve and why the Butterfly measure the Convexity of the Smile Curve?Thanks in advance. Regardsboulala
 
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acastaldo
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Risk Reversal and Butterfly in Forex Markets

March 20th, 2015, 3:44 pm

Imagine a continuous function y=f(x)If you measure y at two different x points one unit apart, the difference is an estimate of the slope: f(x2)-f(x1) If you measure y at three different points x1 x2 x3 one unit apart, the expression f(x1)-2*f(x2)+f(x3) is an estimate of the curvatureA Risk reversal is long one option and short another option at different strikes, so it is like case 1 aboveA Butterfly is long one option, short two options and long another option at three different strikes, so it is like case 2 above
 
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boulala666
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Risk Reversal and Butterfly in Forex Markets

March 21st, 2015, 12:06 pm

nice answer, very easy to understand. thanks!!!