Stocks & Commodities V. 23:8 (14-20): Persistent Option Volatility by Roger Ison, Ph.D.
Do you really understand what your options model is
doing? Letís find out.
If you trade options, you know that mathematical
option models are essential tools and, generally, very good. Market makers rely on option models explicitly;
for example, at least one well-known broker provides tight, mechanically derived, online bid and ask prices for any option, and usually executes trades at their model prices instantly, without human intervention. Brokersí models can be quite sophisticated, taking into account factors other than the theoretical price, such as the market makerís current ďbook,Ē quotes on other markets, anticipated dividends, recent volatility, and the cost of hedging the market makerís position with other
options or futures.
ANALYZING YOUR MODEL
Itís a bad idea to trade against that sort of computational firepower without a decent evaluation of the current option prices. Itís also a bad idea to trade
without having a clear sense of how your strategy might unfold over time. Excellent modeling software is available to traders, and some usable tools are
accessible by web browser, but there are some mistakes traders may make when interpreting these
models. In this article, weíll explore the issue of