What are vanna and volga and when should I care about them?

Question

AcadiFi · Accepted Answer

Vanna is the second partial derivative of option value with respect to spot and vol: dDelta/dSigma = dVega/dSpot. It measures how Delta changes when volatility shifts...

Unlock with Scholar — $19/month

Get full access to all Q&A answers, practice question explanations, and progress tracking.

Start 7-Day Free Trial Compare Plans

No credit card required for free trial

Krystof Lindqvist at Stockholm Currency Arbitrage uses vanna-volga for exotic FX options. A 1-month EURCHF 25-delta risk reversal has vanna around 0.042 and volga near 0.018. When the market vol of 7.2% jumps to 8.4% while spot drops 80 pips, these cross-Greeks dominate the PnL that standard Delta-vega hedges miss.

The vanna-volga pricing method adjusts Black-Scholes prices for exotics by adding three corrections computed from vanilla market prices at 25-delta put, ATM, and 25-delta call strikes. The adjustment is: ExoticPrice = BS + w_ATM * (MktATM - BSATM) + w_RR * (MktRR - BSRR) + w_BF * (MktBF - BSBF). Weights come from matching vega, vanna, and volga of the exotic to the vanillas.

Where this matters: FX barriers, touch options, and multi-callable structures where smile effects dominate. Equity desks use vanna less explicitly but absolutely hedge it — the infamous 'vanna squeeze' during option expiry occurs when dealer short vanna forces spot-chasing flows.

What are vanna and volga and when should I care about them?

Master Level III with our CFA Course

Related Questions

Practice Questions