Black Scholes Equation
- Thread starter lasner
- Start date
There are quite a lot of assumptions in Black Scholes option pricing model, and it is NOT too applicable in the real world.
It's better to use monte-carlo simulation for pricing options.
PA
Absolutely not.
I would highly recommend getting a free trial of Think or Swim and playing with their analytics. (I think you can still do this) They have a couple different models you can use for pricing.
You will find that regardless of the model you use, one quick pop or decline in Implied Volatility will effect your position a lot faster than using the wrong model.
Eventually learn ALL of the greeks and what they will do to/for a position. There's no reason to pump them into a formula every time you want to trade.
I would highly recommend getting a free trial of Think or Swim and playing with their analytics. (I think you can still do this) They have a couple different models you can use for pricing.
You will find that regardless of the model you use, one quick pop or decline in Implied Volatility will effect your position a lot faster than using the wrong model.
Eventually learn ALL of the greeks and what they will do to/for a position. There's no reason to pump them into a formula every time you want to trade.
For a practical application, start watching GLD options.
http://finance.yahoo.com/q/os?s=GLD&m=2010-02
High volume, very liquid, tight spreads, $1 between strike prices out to +-$60 up to a year out.
It's helped me huge in getting a handle on what ITM, ATM and OTM options will do given a change in the underlying. Not what a model says a price ought to be, but what people will actually pay. Which is really all that matters.
http://finance.yahoo.com/q/os?s=GLD&m=2010-02
High volume, very liquid, tight spreads, $1 between strike prices out to +-$60 up to a year out.
It's helped me huge in getting a handle on what ITM, ATM and OTM options will do given a change in the underlying. Not what a model says a price ought to be, but what people will actually pay. Which is really all that matters.
Black Scholes is very easy to use. Just take the numbers and plug them in. The real problem, aka the smudge factor
, is the volatility. In other words, you can observe all the variables that go into the model except for the volatility and using "incorrect" volatility renders the output worthless. And as it has been pointed out above, it doesn't really matter whether you use Black Scholes, Binomial or some other model, the volatility will always remain a problem.Quote from MTE:
Black Scholes is very easy to use. Just take the numbers and plug them in. The real problem, aka the smudge factor
The mathematical elegance in Black Scholes model certainly can be appreciated. But be mindful of the arrogance of the attempt of any quantitative equations designed to tame risk and the market. Unless human behavior can be tamed, no equations are simple enough; and when the equations are simple and elegant, it leaves out an untamed variable: the volatility. Time, interest rate, price are deterministic, and you have to smudge the nondeterministic variable, volatility, to make Black Scholes yield the option price you see.
Once again, be mindful of the arrogance of equations that try to "tame" the market.
You should assume for every single trading day "six sigma" events. Thus, watching into apocalypse nothing "unexpected" can suprise you regarding an unexpected jump in volatility...Expect the worse, hope for the best...
