##### Asked by: Sandra Philley

From the point of view of risk management, being **long convexity** (having positive Gamma and hence (ignoring interest rates and Delta) negative Theta) **means** that one benefits from volatility (positive Gamma), but loses money over time (negative Theta) – one net profits if prices move more than expected, and net loses if …

## What does convexity mean in options?

Convexity is a risk-management tool, used to measure and manage a portfolio’s exposure to market risk. Convexity is **a measure of the curvature in the relationship between bond prices and bond yields**. Convexity demonstrates how the duration of a bond changes as the interest rate changes.

## Why is an option convex?

An option has convexity because **the relationship between the price of the underlying asset and the value of the option is not linear**. The option’s value will accelerate or decelerate depending on it being profitable when exercised.

## Is high convexity good or bad?

Convexity in bonds is a way to measure the bond price’s sensitivity to changes in interest rates. **Bonds with higher convexity are generally considered better investments in markets where interest rates are expected to rise**, and lower convexity is better suited for when rates are likely to remain unchanged or fall.

## How do you interpret convexity?

To interpret a convexity number, **think of it as being the percent change in modified duration from a 1% change in yield**. To estimate what the effect of including convexity in a price change calculation for a 1% change in yield, multiply the convexity by 1%^2=1%*1%.

## What is convexity in volatility?

Volatility convexity **reflects the relationship between vega and volatility**. As volatility rises excessively, all options become concave with respect to volatility because every option is capped at the price of its underlying asset.

## What does short convexity mean?

If you are short convexity, **you become less exposed as the market moves favorably and you become more exposed as it moves the wrong direction** (uh oh). One of the number one rules of the bond trading desk is to, all things being equal, always be long convexity.

## What is a convex trade?

So a convexity trade is where you for instance buy that asset which has an upward- curved value (IE: a bond) and sell something that moves in a straight line with that factor (like some IR derivative). If that factor you’re thinking of (interest rates) really moves fast, you make money.

## What is duration and convexity?

**Duration measures the bond’s sensitivity to interest rate changes.** **Convexity relates to the interaction between a bond’s price and its yield as it experiences changes in interest rates**. With coupon bonds, investors rely on a metric known as duration to measure a bond’s price sensitivity to changes in interest rates.