int volatility is high, thus MBS price is low. I don’t understand the explanation of volatility risk hedging… a blackout in the brain. Anyone? Help! mo34, bigwilly, comp_kid…actuaryalfred?
vol increases the value of the call option therefore decreasing the value of the bond - - remember, as the owner of the MBS bond, you aren’t the one with the call option - the issuer is
call option on the MBS become more valuable when volatility is high.
I would love to help, but you only asekd Mo34, BigW, CSK, and AAF… if you sell an MBS to an investor they buy the MBS which includes an option (i.e as a seller you are short the prepayment option). If interest rate volatility increases it is more likley that this option will end up in the money for the holder of the mortgage (not the MBS). The underlying mortgage could be prepaid earlier so the MBS will decline in value to reflect the fact that the option is worth more.
cvellcfa, bpl1000, yes I understand that option/value part, but not sure how to hedge the risk. strikershank, i will put you on the list 
But why they BUY FUTURE to hedge? That’s the part I don’t understand… Current volatility is higher then future…
foxiegroup Wrote: ------------------------------------------------------- > int volatility is high, thus MBS price is low. > > I don’t understand the explanation of volatility > risk hedging… a blackout in the brain. > > Anyone? Help! mo34, bigwilly, > comp_kid…actuaryalfred? Is that the question where you had to pick futures or options to hedge ? To hedge the int. rate volatility risk in an MBS you have two options, you either buy options (to offset your short call option), but you don’t want to do this now because implied volatility is high, so the options are expensive. The other way is to dynamically buy and sell futures contracts (similar to delta hedging in options). If int. rates decrease, you’ll have to buy back some futures as the MBS loses value, and vice versa when int rates increase.
I got f@cked on this one too. The implied was > than the expected. If expected is LOWER, wouldn’t this mean options are CHEAPER. Thus, go with options vs. futures. Aghhh!
which reading is this frm ? I need to review this …
If expected is lower, this means it’s currently too high … I missed this one as well, but I’m hoping to see it in the real thing as it was not covered in Schw.
Rudeboi Wrote: ------------------------------------------------------- > which reading is this frm ? I need to review this > … SS 9, Hedging MBS with either futures or options
Yeah I missed this one. Implied was greater than Expected, so Options Costs are Higher than they should be, so sell options. ----that’s what I picked…but its Buy Futures… I guess if the options costs decrease than the MBS price is going to increase so you …
mo34 Wrote: ------------------------------------------------------- > If expected is lower, this means it’s currently > too high hmmmmm, I see where you are going with this, ok but I don’t like it.
hey! My list is working! Yes, that’s what I am asking. In MBS, we are shorting an option(prepay), to cover that short call, we can buy option, BUT, now expensive. (Thanks much! I understand this far.) The rest, see if I can follow you: just delta hedge. Since option price high, MBS price low, we can buy MBS to form a coverd call: If we sold 1 call, we need to buy delta MBS to hedge. (I should still be with you now.) Here is the jump: Since MBS (spot) is not an option, we can buy future to hedge. (still with you.) HOWEVER, future volatility is LOW! thus future price is HIGH! then what’s the difference? Buy option is high, and future is also high!
Fastest way for you is to go to page 60, reading 30 and read the part related to volatility risk and prepayment risk.
Mo what volume is this I’ll have to check it out later today.
My understanding is this: option price is based on implied volaility. So if implied volaility is high, that means option is expense…as a MBS holder, investor sold options, to hedge is to buy call options back. If option is expense, then you want to use future to hedge. Am I correct?
WS, yes, we sold a call, now don’t want to buy back that call at higher price. But then, why buy future? Still high… just to save some premium? It might be just best amoung choices listed.
Yes, given the choice. Future or option. Furture will be a little cheaper.
i thought the decision whether to buy or sell is dependent upon the expected direction in rates
bigwilly Wrote: ------------------------------------------------------- > Mo what volume is this I’ll have to check it > out later today. Volume 4.