American Binary

[mensatrader]

Hi all

When you long american style binary options, you are actually long vega and gamma? In the Dynamic Hedging book, the author said that if you are short american binary, then you are long volatility. Why is that?

many thanks

 

[Shakone]

American style?

Is the spot above the strike in the book?

 

[mensatrader]

Is the spot above the strike in the book?

Based on the Dynamic Hedging book, it does not specify whether it is amercan binary call or put; but it only states that when it is getting close to the money, it is long vega and it is long gamma in decreasing amount;however it is always long volatility for the american binary seller. Don't understand why?

BTW, mate, did you see my previous thread about the european binary FX?

cheers

 

[Shakone]

Based on the Dynamic Hedging book, it does not specify whether it is amercan binary call or put; but it only states that when it is getting close to the money, it is long vega and it is long gamma in decreasing amount;however it is always long volatility for the american binary seller. Don't understand why?

BTW, mate, did you see my previous thread about the european binary FX?

cheers

If it's an American Binary, then you exercise as soon as the level is hit, because you can't gain any more money, the maximum payoff is reached. So this sort of question doesn't really make sense for American Binary. For European Binary it does, and then you should ask as I did, where the spot is relative to the strike.

 

[Shakone]

You have to be specific about exactly what you're asking with this sort of question, because the devil is in the details. Change one thing and the answer can be the exact opposite.

Consider you are long a European Binary Call option, strike 100. If the spot is 150, you can't gain anything more if price goes to 200 because the binary pays 1, but you can lose if price goes below 100. So in effect you want volatility to go down. Volatility increasing makes the option worth less. This is not true of the normal vanilla call option. Now again on the Binary, if spot is at 50, then you will receive nothing at maturity unless it moves, so you want volatility to increase. Two different answers depending on where the spot it.

I'll have a think about what it means for the seller to be always long volatility in the example you gave. I may have overlooked something.

 

[mensatrader]

If it's an American Binary, then you exercise as soon as the level is hit, because you can't gain any more money, the maximum payoff is reached. So this sort of question doesn't really make sense for American Binary. For European Binary it does, and then you should ask as I did, where the spot is relative to the strike.

again, based on the book: european binary is a risk reversal by construction or relevant to the third moment; but the american bet is in general monotonic in gamma and the american bet will always be long volatility for the seller; the american binary will be positive gamma everywhere (for the buyer) when the delta hedge against the option incurs a negative carry; the profile of the american bet will look like that of a risk reversal - a third position moment different from 0 - if the delta hedge of the owner earns a positive carry superior to the time decay of the same binary on the same asset without drift

It is really difficult to understand the philosophy here.....

 

[mensatrader]

You have to be specific about exactly what you're asking with this sort of question, because the devil is in the details. Change one thing and the answer can be the exact opposite.

Consider you are long a European Binary Call option, strike 100. If the spot is 150, you can't gain anything more if price goes to 200 because the binary pays 1, but you can lose if price goes below 100. So in effect you want volatility to go down. Volatility increasing makes the option worth less. This is not true of the normal vanilla call option. Now again on the Binary, if spot is at 50, then you will receive nothing at maturity unless it moves, so you want volatility to increase. Two different answers depending on where the spot it.

I'll have a think about what it means for the seller to be always long volatility in the example you gave. I may have overlooked something.

thx,that makes sense for the european style bet; but for american style, why the book can say it is long volatility for the seller but at the same time it says when it is close to the money the american binary is long vega for the owner??

 

[Shakone]

So we're talking about one-touch options yeah? American option implies choice of the exercise time, but that's not the case here, because you execute as soon as the level is touched.

The Vega is always positive for a one-touch option, for the buyer.

 

[mensatrader]

So we're talking about one-touch options yeah? American option implies choice of the exercise time, but that's not the case here, because you execute as soon as the level is touched.

The Vega is always positive for a one-touch option, for the buyer.

yeah, exactly one-touch option!!

Intuitively I can understand that the more volatile the underlying, the more probable the barrier will be touched, so that's why long vega for the buyer, right?

 

[Shakone]

Yes. Just tell that idiot Taleb to do one :cheesy:


I'll have a think about it tonight to see if I'm missing something.

 

[mensatrader]

Yes. Just tell that idiot Taleb to do one :cheesy:


I'll have a think about it tonight to see if I'm missing something.

thx, mate. Happy to discuss with you later!