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Vanna-volga pricing

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  • Wystup, Uwe

Abstract

The vanna-volga method, also called the traders' rule of thumb is an empirical procedure that can be used to infer an implied-volatility smile from three available quotes for a given maturity. It is based on the construction of locally replicating portfolios whose associated hedging costs are added to corresponding Black-Scholes prices to produce smile-consistent values. Besides being intuitive and easy to implement, this procedure has a clear financial interpretation, which further supports its use in practice.

Suggested Citation

  • Wystup, Uwe, 2008. "Vanna-volga pricing," CPQF Working Paper Series 11, Frankfurt School of Finance and Management, Centre for Practical Quantitative Finance (CPQF).
    • Handle: RePEc:zbw:cpqfwp:11
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