Pricing Digital Caps/Floors
Posted: May 21st, 2006, 11:34 am
Dear all,Could you let me know what adjustments traders make while pricing digital caps and floorsLets assume I am buying a digital collar on US LIBOR for 5 yrs, with strikes 5% and 4% and payoff =1% respectively.Am, I right to assume that traders will make 1 vol adjustment, i.e. sell the cap 1 Vol higher and buy the floor 1 vol lower. Additionally if traders are going to hedge this using tight cap and floor spreads, then they may actually, price the cap with a strike of 4.90%, and floor with a strike of 3.90%.THANKS!!