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Why people call (vol call - vol put) risk reversal when risk reversal actually is (call 25 delta -put detlta +25)? when constructing volatility surface? The vol of risk revesal should not be vol call - vol put? Is the terminology just for the sake of convenience?

thanks

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  • $\begingroup$ where do you have this from? From the market of options on spot FX? $\endgroup$ – Ric Jul 7 '16 at 7:08
  • $\begingroup$ This is from Wiki, "Market practitioners use the term implied-volatility to indicate the volatility parameter for ATM (at-the-money) option. Adjustments to this value are undertaken by incorporating the values of Risk Reversal and Flys (Skews) to determine the actual volatility measure that may be used for options with a delta which is not 50." $\endgroup$ – user4224870 Jul 7 '16 at 15:56
  • $\begingroup$ CALLx=ATM-1/2RRx+FLYx $\endgroup$ – user4224870 Jul 7 '16 at 16:02
  • $\begingroup$ CALLx=ATM+1/2RRx+FLYx and PUTx=ATM-1/2RRx+FLYx so RRx=CALLx-PUTx where CALLx is vol of %xdelta call and PUTx is vol of %xdelta put. So the term is in general used in both. $\endgroup$ – user4224870 Jul 7 '16 at 16:10
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Its the difference between the strategy (i.e call - put) and the actual trading convention.

In the market - the quotation convention is to use the 10/25 delta points. Its so traders who are delta hedging have an easier time of understanding how many contracts they need to hedge.

If you talk about it in more theoretical terms then you can have any combination of delta/strikes/percentage to define a risk reversal.

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Essentially you are trading spot vs. implied volatility with a RiskReversal so you have no exposure to Vega or Volga, but what you do have with a RR is exposure to Vanna, which is 2nd order greek and measures how quickly vega changes at the spot level. ATM is exposed to Vega, but not Vanna or Volga and with a Butterfly, you are trading the wings of the smile so your exposure is Volga, but no Vanna or Vega. Hope this helps.

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