0
$\begingroup$

I'm trying to estimate the volatility surface of an especially illiquid options market; only ATM quotes are available (so Vanna-Volga approximation is not viable) for options on quarterly futures for the next year -- but I am working with ITM and OTM daily options that go on for the next seven years. So my questions are:

  1. How can I rescale my quarterly IV to a daily level -- especially given the seasonality of the power market?
  2. How can I create a volatility surface using just the ATM volatility and (presumably) the Greeks?

Your help is greatly appreciated!

$\endgroup$

1 Answer 1

2
$\begingroup$

This is a hard problem with only very approximate solutions

That ATM vol is the typical daily move in case the underlying ends flat in 3 months - it has very little to do with the expected daily move tomorrow and especially the full 1-day implied distribution that you seem to need. You simply can't 'rescale' vol in the way you want - the 1 day and quarterly vol are very different things.

I would suggest you use realized variance/skew/kurtosis to try to gain extra information to build a 1-day distribution, doing something like fitting a skewed Student's-t to the realized data. (You would input your seasonality here). Then add a vol termstructure that matches the ATM IV data you have. I'm basically suggesting you add a VRP to the realized data.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.