In the famous article of Demertifi, Derman et al (1999), the authors, in the appendix, show that it it necessary to have options weighted inversely proportional to the Square of the Strike in order to have a constant vega in a portfolio of options. $O(S,K,v)$ represents a standard Black-Scholes option of strike $K$ and of total variance $v = \sigma^2t$ when the stock price is $S$.

To show that, the authors start by deriving the sensitivity $V_O$ to the total variance of an individual option.

And then, they write the following equation:

$$ V_O = t \frac{\delta}{\delta v}(O) $$

I do not understand why there is a $t$ in front of the derivative $\frac{\delta}{\delta v}(O)$.

  • 1
    $\begingroup$ There are various small variations in definition of vega, for example $\partial / \partial \sigma$, or $\partial / \partial \sigma^2$, or even $\partial / \partial \sigma \sqrt{\tau}$. In Derman's paper he defines vega as $\partial / \partial \sigma^2 = t \partial / \partial (\sigma^2 t)$ $= t\partial / \partial v$ $\endgroup$ Oct 30, 2020 at 6:52
  • $\begingroup$ I agree with you. Then, it means that here, it is not the sensitivity to the total variance but just to the variance. I am quite surprise that it is possible to find a typo in such a famous paper, $\endgroup$ Oct 30, 2020 at 20:52


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Browse other questions tagged or ask your own question.