hi all,How's the realized vol calculated? say for a usd 1m10y straddle. Should the realized vol be calculated as the 10y rate move over the 1m period (as >95% of the risk goes into this bucket anyways for a 1m10y swap), or measured as this fixed-dates forward rate changes? Assuming it is the 1st version, what's the pnl implication if the realized vol is higher than the bp vol at pricing? i.e If the realized vol measured as eod of day changes within the month is higher than the initial bp vol, and assumed gamma trade every day. Does it necessary generate a profit? I am a new addition to the option desk and would like to gather more understanding of the gamma trading aspect.

The short answer to your question whether higher realized vol on a delta-hedged long option position necessarily generates a profit is no, transactions costs can get in the way for starts. I found that a very good way to learn about this was to set up delta hedging simulation exercises where I could vary realized vol and transactions costs and test various strategies regarding how often to hedge. Do try it, it is quite educational.

totally agree. as a matter of fact I did run some test on calculating the daily gamma and calculate it's pnl using eod curves assuming I can get it at mid. i.e bought a straddle, keep normal delta neutral and just hedge eod back to flat. the sum of all gamma pnl plus the terminal swap value is then compared to the prem (given small option term, the discounting impact on the daily gamma pnl vs prem at expiry is ignore for now). I found that the size of the profit (or less) is only somewhat relevant to the realized vol over the term vs implied bp vol up front. A hypothetical situation would be the market didn't move until on expiry date, the mkt move just over the B/E point so the bought swaption is up in money. but obviously the realized vol would be much lower than the implied since most of the days the mkt didn't move at all. so this also suggest that implied vs realized doesn't really give a good picture on the profit. then it gets to a point, what's gamma trading then? it has been said gamma trading is all about realized vs implied...