Implied Volatility and Exotic options

M

MrAgi1

I am not familiar with the maths behind the Black Scholes. However, I understand the basic concept behind it. I know volatility is important in options pricing.

I know that if there is an increase in the number of buyers of calls and or put options, there is an increase in implied volatility; Assuming every other factor is held constant the increase in IV should result in an increase in the options price.

Now, My question is with binary options. I know it is also priced with the Black Scholes valuation. However, imagine there is an increase in the number of people buying ITM binary call options from an OTC bank/broker. From my understanding of the pricing, the IV should go up and the price of the binary options should increase assuming all other factors like the stock price remain unchanged. Does the increase in IV affect the standard vanilla options of the same underlying that is traded on an exchange?
If there is no effect on the vanilla options does that mean the IV of the binary option is different from that of the vanilla options?
 
Let me give a fake example to make my question clear.

SPY is at 350. Over the next 30 days, price is constant as well as other factors. Let's say Barclays bank is offering a one-touch option with a 250 percent payout that price would touch 395 in the next 30 days. The number of buyers and sellers of SPY vanilla calls and put is fairly the same and IV is constant on all exchanges. Imagine that billions and billions of the one-touch options are heavily purchased all of sudden from Barclays. Does it affect the price of the one-touch option making it costlier and in turn does it directly affect the vanilla options of SPY on the exchange making them costly also?
 
The general answer is obviously yes. The exotics desks will hedge themselves with vanillas and, as a result, will drive the vols. It's already happening in less liquid markets/names. In the index space, for example, KOSPI and NKY vols are largely driven by the flow from auto callable hedging. It's less visible in the US indices were the exotics/structured notes flow is much smaller compared to the size of the market.

Now, pure continuous binary options rarely trade because it's too risky for both dealers and expensive for the players. Instead, you get a lot of barriers sold as part of various "cheap" structures like down-and-out puts.
 
Hi everyone,

A am a "bit" less experienced in the exotics but can see their benefits to one's trading. Could you please recommend a broker that can give access to the light exotics such as out performance options or the best of/worst of options?

Many thanks!
 
You must log in or register to reply here.
Back
Top