A review of IV (Implied Volatility) and its usefulness

[Martinghoul]

Quote from OddTrader:

http://www.elitetrader.com/vb/showthread.php?s=&postid=2528592#post2528592



That's really great!

I think you're going to re-write (aka re-invent) the foundation theory of options pricing! Thanks!

DMO is exactly right...

Ideally, all option pricing models are based on arbitrage pricing (replication, etc). Arbitrage pricing has flaws, as lots of assumptions need to hold for things to work.

What dmo is saying is that ultimately everything is about equilibrium pricing and IV is a measure of the supply/demand equilibrium. Trouble is that it's really difficult, if not impossible, to implement good equilibrium pricing models, so we just settle for things that are imperfect, but tractable. Maybe the issue is that there hasn't been enough effort applied in the right area...

 

[OddTrader]

Quote from Martinghoul:

What dmo is saying is that ultimately everything is about equilibrium pricing ...

1. Unsure whether DMO and you are talking about exactly the same explanation. Are you sure DMO talking about "IV IS just demand" is the same thing as your "everything is about equilibrium pricing"? As if IV is no different to evrything, the why do we need to use IV for options?

Anyway I personally just don't feel either of you wouuld provide a good understanding of IV in relation to options.

Quote from Martinghoul:

... IV is a measure of the supply/demand equilibrium.

2. Specifically, what is the IV measure in relation to (what?) other measures/ factors, and can you provide detail for supply/demand of what? An example would be appreciated. Thanks!

3. Below are some relevant comments.

http://www.elitetrader.com/vb/showthread.php?postid=2528889#post2528889

Quote from weewilly:

Sophistry.

I view demand as actual order flow -- real buying or selling pressure. Even in the absence of any order flow (demand), market makers are required to quote reasonable, two-sided markets. Those quotes imply vol.

Your example of a of a 70 put on GS being zero bid is hardly proof of anything. The option is 95 points away from the market and soon to expire. That there is no public or market maker bid for that option is not proof that IV is demand.

Look at the AUG 102 puts on XSP. They have no open interest and did no volume today. I read that as no demand. The market appears to be somewhere around 2.56-2.84. Those prices imply vol of about 21-22%.

quod erat demonstrandum.

 

[asiaprop]

i think we all agree on the fact that vol is a function also of spot relative to strike, so yes there is a relationship and I never contended that.

My point was that it does not pay (relative speaking) to establish a pure directional view through an option position unless you are absolutely right on a number of variables which, I argued earlier, the average retail guy is over time incapable of correctly predicting. The same applies to rates options as well (caps/floor/swaptions, I have traded them professionally myself)

Quote from Martinghoul:

Anything is possible, including a version of English language where "not plausible"("not independent") = "not independent"...

Just indulge me, pls, my friend. What exactly is your point? Without reference to any previous posts, yours or mine, what are you saying? Specifically, in the world of interest rates (let's take vanilla swaptions, nothing exotic) are vol and direction independent or not?

As to what I am trying to say, I have said it arnd five times now, elaborating in various ways. I will now be very clear:
1) There IS NOTHING WRONG with using trades that have a volatility component to express a view on either vol or direction or both. There are various circumstances where different types of trades will offer specific advantages.
2) Your point about being able to replicate any directional trade done through options using straight underlying is NAIVE.

Is that clear enough for you?

 

[atticus]

Quote from asiaprop:

are you imprecise on purpose? I dont get your point about "bid/offer"???

The point of this thread was about IV and its usefullness. I mentioned that one advantage of trading isolated IV is due to the empirical evidence of serial correlation. Show me where you want to trade direction but by implementing an options position you gain edge over a pure delta position.

Quote from asiaprop:

i think we all agree on the fact that vol is a function also of spot relative to strike, so yes there is a relationship and I never contended that.

My point was that it does not pay (relative speaking) to establish a pure directional view through an option position unless you are absolutely right on a number of variables which, I argued earlier, the average retail guy is over time incapable of correctly predicting. The same applies to rates options as well (caps/floor/swaptions, I have traded them professionally myself)

You are absolutely full of shit.

 

[Bigpipn]

Asia- you have no idea how far underwater you are in this exchange with Martin and Atticus. Martin- how is everything going with you mate?

 

[asiaprop]

atticus, my friend, still licking your wounds from your Buffet desaster? ;-)

Quote from atticus:

You are absolutely full of shit.

 

[atticus]

Quote from asiaprop:

atticus, my friend, still licking your wounds from your Buffet desaster? ;-)

ESL is warranted here. You ran from the Buffett thread with your tail between your legs. Here is your M.O.:

Make unsupported BS claim

Get busted

Make unsupported BS claim conditional using "relative" and "retail"

Get busted again

Go off topic in lieu of offering support to BS claim

Get busted again

Mention fantasy exotics desk

Get busted again

 

[asiaprop]

so those are the options experts on ET, lol. Full of air nothing else. Everyone who reads up on that thread knows precisely whats going on. You were taken apart like a dog.

All the control to the pretentious, just like in real life.

So what value do you have to add to the OP's question, options god? I am slowly getting the impression you are exactly one of those who fell pray to the broker bla about vertical spreads, ratios, and credit plays, lol.

Quote from atticus:

ESL is warranted here. You ran from the Buffett thread with your tail between your legs. Here is your M.O.:

Make unsupported BS claim

Get busted

Make unsupported BS claim conditional using "relative" and "retail"

Get busted again

Go off topic in lieu of offering support to BS claim

Get busted again

Mention fantasy exotics desk

Get busted again

 

[atticus]

Quote from asiaprop:

so those are the options experts on ET, lol. Full of air nothing else. Everyone who reads up on that thread knows precisely whats going on. You were taken apart like a dog.

All the control to the pretentious, just like in real life.

So what value do you have to add to the OP's question, options god?

Buffett's own MTM loss = his GAAP loss reverse pool; which proves there was/is no hedge. You and Buffett lose. You eat dog?

Quote from asiaprop:

Show me where you want to trade direction but by implementing an options position you gain edge over a pure delta position.

Perhaps any bull/bear index risk-reversal into an index rally/decline, matched for initial delta. I don't see how retail is constrained from trading the risk-reversal.

 

[asiaprop]

lol thats not a pure directional play, you lose again!!! If you knew anything about the huge Eurostoxx option play that went through Deutsche last year you would know what I am talking about.

I am outa here, this is bordering to a complete waste of time. OP, ask atticus he kows it all (so he thinks).

Quote from atticus:

Buffett's own MTM loss = his GAAP lose reverse pool; which proves there was/is no hedge. You and Buffett lose.



Perhaps any bull/bear index risk-reversal into an index rally/decline, matched for initial delta.