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A Convex Trade
 

chocolatebear's picture
(Monkey, 33
 
Points)
 on 4/20/11 at 5:42pm

Hiya,
I read the other day about something referred to as a convex trade, seems as if that is a good thing, but could someone explain a bit more?
Thanks

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quag_mire's picture

probably means a trade where

ST
 
Points)
 on 4/20/11 at 5:46pm

probably means a trade where you're long gamma (gamma is a measure of convexity), which is a good thing if you're delta hedged since gamma will make you money regardless of where the underlying moves (i'm referring specifically to options)

IlliniProgrammer's picture

Could mean different things

ST
(Almost Human, 9,244
 
Points)
 on 4/21/11 at 11:00am

Could mean different things depending on the context. Gamma, for instance, is only a term used in equities so far as I know.

Convexity is just like what it means in Calculus class- the price sensitivity of an asset to some factor (like interest rates or the value of the underlying stock) is curved. If that factor moves in the right direction for you, the price goes up faster and faster as stuff moves in that direction. If that factor moves in the wrong direction, the price goes down slower.

So a convexity trade is where you for instance buy that asset which has an upward- curved value (IE: a bond) and sell something that moves in a straight line with that factor (like some IR derivative). If that factor you're thinking of (interest rates) really moves fast, you make money.

You can do basically the same thing with equity options with a bet on volatility. But folks tend to refer to that as long vol or long gamma and less as long convexity- though people will still understand you if you use the term.

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derivstrading's picture

Draw a convex graph on a X-Y

ST
(King Kong, 1,351
 
Points)
 on 4/21/11 at 10:34am

Draw a convex graph on a X-Y axis. X axis representing an asset price, and the Y axis representing the price of a derivative security you are holding. Now look at what the price of the derivative does when the asset price increases by A and decreases by A. If you are long the derivative, you make more if the asset moves up than you lose when the asset moves down, even though the move in the asset was the same both ways. Thats convexity in a nutshell.

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chocolatebear's picture

Got it, thanks guys.

(Monkey, 33
 
Points)
 on 4/21/11 at 2:35pm

Got it, thanks guys.

Revsly's picture

Gamma is not only an equities

ST
(King Kong, 1,722
 
Points)
 on 4/22/11 at 8:49am

Gamma is not only an equities concept... it's a core part of anything options related. In this realm there is convexity with regards to various partial derivatives. When people normally think of gamma, they think of the partial derivative of delta wrt the underlying, but there are many others.

For example another very important one is GoV (or Gamma of Vega or Vomma, whatever you want to call it) which is the partial derivative of vega wrt vol. What does this mean? If you are long gov, as vol increases you get longer vol and as vol decreases you get shorter vol. As a result of this position of strength, you have to pay up for it.

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