Can someone explain the "vanna decay" story? I am looking for something at least somewhat logically consistent (not even asking for a model cause I gave up on that).
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Possibly you are asking about something else since you used the phrase “vanna decay” which I am not familiar with?
People refer to this stuff as “gamma hedging” or “vanna hedging” which is very unhelpful, since no gamma or vanna exposure is being hedged. It’s just sensitivities of delta to moves in spot or implied volatility.
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Ok, thanks, not exactly my question but to your point: can you walk me through a "verbal" impulse response functions and tell me some identifying assumption to belive the vanna hedging *causes* prices to go down. Suppose we start from an equilibrium. What is the causality story?
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It would be something like “implied vol goes up” (because someone buys options or whatever, doesn’t matter) which means dealer delta increases (assuming they are long vanna) which means they need to hedge by selling spot, and selling spot causes the price to go down.
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I think he's specifically referring to put hedges unwinding due to charm and vanna as position approaches expiration / vol contracts
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