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We market make in highly liquid, near term options markets. I want to build a risk report that tells us how our portfolio's greeks will change as the underlying moves. This is for risk management in the face of unusually large moves, such as 2, 5 and 10% moves in the underlying. We are only trading vanilla options.

My starting vol curve takes IVs from the current market at every strike and lightly smooths them. I want to 'shock' the underlying & the vol curve in several different directions. Obviously, it is easy to shock vol up by 30% of current vol, but how do I predict how the curve moves when I shock the underlying up 5%?

Given that I am modeling large moves, I'm leaning towards using the "sticky delta" approach where the options with a given delta keep their volatility.

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  • $\begingroup$ Shocks are bit too much to keep the vols same. I am assuming you are building a short horizon model, if stock price moves down by 30%, vols should go crazy. Why not look into some other models, such as Heston or SABR? Or build an empirical vol stock price model based on extreme moves in the past, which would be my first choice to try $\endgroup$ – adam Feb 29 '16 at 15:32

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