A Convex Trade
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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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)
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.
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.
Got it, thanks guys.
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.
Convexity Trades (Originally Posted: 03/19/2012)
Hi
I've been reading about a CTA that has good rebounds after drawdowns due to their ability to enter into positive convexity trades rather than being trend followers.
Could someone explain this to me if possible and what are some examples?
Many thanks.
First off, do you have a good understanding of the concept of convexity in general? Wikipedia and Investopedia have good summaries.
thanks - i understand that convexity is the relationship between the price and yield of a FI instrument.
not sure how this correlated to CTA's though.
Well, that's not entirely right. There are two related but distinct concepts called convexity in finance.
BOND convexity is a measure of how sensitive a bond's price is to moves in interest rates.
OPTION convexity (which is what's at issue here), or gamma, is the rate of change of an option's delta as the price of the underlying changes.
In the context of your original post it probably refers to trades where CTAs (who almost exclusively use options as you probably know) are able to "recover" from drawdowns by using high-gamma options to "accelerate" their investments (only works if you're right though.) A straddle is also a form of gamma trade. In a straddle you make money as long as the underlying moves in either direction, and if you make a straddle with high-gamma options, the more it moves the faster your gains increase-Delta becomes greater and greater, so a $1 increase in the underlying is >$1increase in your option's value (and increasingly more so every with each $1 move).
I'm not an options expert so hopefully someone on here who is can confirm this/give you some additional advice.
thanks - that's why i've been so confused as all i've been able to find is simple convexity definitions using bonds, noting on options.
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