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A basic question.

When traders structure a product in which they are long an option, how is the volatility surface shifted to take into account a margin ?

Is it a multiplicative coefficient, say 95% of the initial surface level ?

Is it

  • if 10 < vol < 20, shift 1 point
  • if 20 < vol < 30, shift 2 points
  • and so on

Is it something else ?

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Vol surface is parameterized and u shift each parameter in absolute value depending on your exposure. (u can be buying vol but selling skew) e.g alpha + 1, beta - 2 whatever alpha and beta stands for in your model. However shifts depend usually on the liquidity of the listed market in which you need to hedge rather than the vol level. If trade is risk reducing to the book/you like the position, its not uncommon to price at mid to try to win the deal

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