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Let's see: You come to me and you say I am willing to buy from you OTM call option for $3 ( You've calculated that volatility today is let's say 20% and you are going to make good money on this trade because the price WILL make a move greater than $3 before expiration). But I tell you that I...

Why? Don;t the have the valid argument that they have repaid the TARP money with interest and others who didn't are exempt?

Which stocks?

I would say that theoretical options price is calculated based on IV ( and is equal to the current market price). http://en.wikipedia.org/wiki/Implied_volatility

Next the buyers are coming because they realize the option is underpriced relative to expected stock's move. The market makers realize that too based on rising volume and rising actual volatility of the stock. They adjust the option quote based on the market's expected future volatility and...

What if there are no buyers or sellers. The options are still quoted, right? Based on their theoretical price and what market makers expect their future volatility should be, right?

Can you clarify what you mean by demand/supply thing? Do you mean their trading volume or what? What drives demand/supply? Wouldn't be it the notion that the option is underpriced/overpriced relative to upcoming move of the stock? Which in turn should adjust the option theoretical price...

Why would market prices be different from theoretical price? This is not obvious to me. If they are different this is an arbitrage opportunity that does not last long. Theoretical price should be derived off some future volatility, probably it's estimate. Right?

Don't think so. Why?

0.

But the future volatility estimate is used to calculate the fair option price, right?

How are the options priced if IV is unknown?

How would you adjust your leverage if volatility moves sharply higher?

This is all done by the markets themselves as the survival of the fittest. No need for social engineering experiments. BTW do they have tax on trucks deliveries? They should.

But how are the options quoted then without complete pricing model ( missing IV) ?

This is funny: he is about to rob them in broad daylight and he asks them to oblige meekly.

What for? What for? No, I have nothing to add unless I understand the reason of them being so important to OP. As for you unless you actually make money with them I don't think you are qualified to talk about their importance.

Do you actually make money with this strategy?

GS did repay TARP. As for lending they won't lend until the general economy heals and conditions will be right. It takes time and it does not work on government directives.

They did repay the TARP money with billions of profit to the government. What did they use it for is irrelevant to the fact. Government got it's money back for it's loan.