Help with SIG Interview Question about Options

[OTM-Options]

I think I see my mistake. Instead of dividing all the expectancies by number of outcomes, simply add them all together. The total expectancy for the dice roll game is 3.486 which rounds to 3.5. Then bid under that by a few cents and offer above.

I'll take a crack at the second part later.

IMO ..... You also have to take into account a guaranteed payout of $1.00 - that would lower the bid.

 

[Gambit]

IMO ..... You also have to take into account a guaranteed payout of $1.00 - that would lower the bid.

The 1.00 payout is already accounted for in the calculation:
prob of payout is 1/6 expected payout is 1.00
1/6 * 1.00

 

[garachen]

Its similar to the dice problem that they have been known to ask. You roll a die and get the payout (if you roll a six, you get $6, if you roll at 2, you get $2). How much are you willing to pay for this contract? The follow up is, how much are you willing to pay up front) for the option of rolling again?

I'd say my intuitive answer is that fair value is $4.25 for the pay up front for the second throw option. Feels too easy so maybe 80% chance of being correct.

 

[newwurldmn]

Yup. That's the answer.

 

[Windlesham1]

I'd wait for somebody else to make a market then I'll bid under the bid/offer spread, I'm too uneducated to figure this out,but 16 years of trading options has taught me NEVER to make a market

 

[heypa]

I would never play the game of single roll using long term probabilities. I would only offer $1 which no one would take. I dislike gambling.

 

[newwurldmn]

The question isn't about personal preferences. It doesn't matter if you don't believe in market making or if you can only see this as a one time roll.

Expressing personal preferences as an answer poorly hides your inability to even try to think through the problem.

 

[OTM-Options]

I'd say my intuitive answer is that fair value is $4.25 for the pay up front for the second throw option. Feels too easy so maybe 80% chance of being correct.

Yup. That's the answer.

The question isn't about personal preferences. It doesn't matter if you don't believe in market making or if you can only see this as a one time roll.

Expressing personal preferences as an answer poorly hides your inability to even try to think through the problem.

garachen didn't think through the "problem" - he took the easy way out and Googled It

 

[newwurldmn]

garachen didn't think through the "problem" - he took the easy way out and Googled It

I doubt that. It was the fundamental question same question as the OPs.

 

[nobiggie32]

I would never play the game of single roll using long term probabilities. I would only offer $1 which no one would take. I dislike gambling.

MINE. LOL, gambling? It's as close as free money as it gets to buy for less than 3.5