New invention for the derivatives market - How to profit of it?

[thecoder]

@VolSkewTrader, as said you are stuck in the status-quo. Never mind. you can have your own view and use the classic PUT for your view.
But the whole point of FairPUT was to bring fairness into the game as the payout of the PUT is wrong since the 1973 Black-Sholes paper! The payout of the classic BSM PUT might be easy to understand and apply, but it's mathematically simply wrong. That's the whole point I'm saying and developing a fix with this new FairPUT.

 

[xandman]

In my solution the probabilities for the two sides (up and down) dictate the risk/reward payout scheme, as it should be in every fair game.
For both sides (up and down) with the same probability, the reward (ie. the payout) has to be equal, ie the same...

By your definition, you are assuming a normal distribution of returns. You need to understand the simple associativity between payouts and expected returns. A step back from 1973 BSM. We have come a lot further with models for other distributions but BSM still holds strong.

This works not only in a normal distribution, but also in a lognormal distribution like in markets where prices cannot become negative.
The key for this to work is the corresponding same z distance from the mean, in my case from the strike K.

You are saying that you will refuse to list call strikes that exceed the absolute distance between 0 and ATM because it doesn't fit your normally distributed world.

 

[VolSkewTrader]

@VolSkewTrader, as said you are stuck in the status-quo. Never mind. you can have your own view and use the classic PUT for your view.
But the whole point of FairPUT was to bring fairness into the game as the payout of the PUT is wrong since the 1973 Black-Sholes paper! The payout of the classic BSM PUT might be easy to understand and apply, but it's mathematically simply wrong. That's the whole point I'm saying and developing a fix with this new FairPUT.

Like I said before. "FairPut" doesn't work for stocks or equity indexes where prices can't go below zero. The Bachelier options model uses a mathematically correct version of your "FairPut", and its been around for many years, so your idea is nothing new...it's actually a poor copycat. I currently use a version of the Bachelier model to theoretically price my options in energy products. Even if I raise my IV to 1000% my calls and puts have the exact same delta. I switched from a BSM-based lognormal distribution pricing model to a Bachelier normal distribution pricing model only after WTI crude prices went deeply negative in April of this year. As a result, my puts now have equal payout as the calls...which unfortunately for you, is not possible for stocks and equity indexes.

 

[thecoder]

By your definition, you are assuming a normal distribution of returns. You need to understand the simple associativity between payouts and expected returns. A step back from 1973 BSM. We have come a lot further with models for other distributions but BSM still holds strong.

No, it's not the case. At first sight it might look so, but it's not. I'm not the big teacher to explain this well.
Here the pure math should be the teacher.

You are saying that you will refuse to list call strikes that exceed the absolute distance between 0 and ATM because it doesn't fit your normally distributed world.

Hae? Hmm. nope, any strike can be listed as usual.
Just explain or give an example what you exactly mean.

 

[thecoder]

Like I said before. "FairPut" doesn't work for stocks or equity indexes where prices can't go below zero.

That's true! This version of FairPut works only for lognormal distributions, ie. where stock prices cannot be negative.
But it's easy to have a similar one for the normal distribution (ie. where also negative prices are possible); that's even much much simpler to develop.
But why waste time and effort on that, as there is no demand for this in the real world.

The Bachelier options model uses a mathematically correct version of your "FairPut", and its been around for many years, so your idea is nothing new...it's actually a poor copycat. I currently use a version of the Bachelier model to theoretically price my options in energy products. Even if I raise my IV to 1000% my calls and puts have the exact same delta. I switched from a BSM-based lognormal distribution pricing model to a Bachelier normal distribution pricing model only after WTI crude prices went deeply negative in April of this year. As a result, my puts now have equal payout as the calls...which unfortunately for you, is not possible for stocks and equity indexes.

I of course know that Bachelier in 1900 or so had developed his own option pricing model, but I didn't and don't know the details. I came to the FairPut idea fully independent just by myself by applying pure logic.
Thanks for making me aware of his work. I'll try to study his method. But I think his method works only for normally distributed prices, not for lognormally distributed prices.
So, there we have it: mine is a different one from his, so mine is indeed a novel solution!
And: you just confirmed that the general idea is a useful one, and that there is indeed demand for it

 

[VolSkewTrader]

That's true! This version of FairPut works only for lognormal distributions, ie. where stock prices cannot be negative.

I of course know that Bachelier in 1904 or so had developed his own option pricing model, but I didn't and don't know the details. I came to the FairPut idea fully independent just by myself by applying pure logic.
Thanks for making me aware of his work. I'll try to study his method. But I think his method works only for normally distributed prices, not for lognormally distributed prices.
So, there we have it: mine is a different one from his, so mine is indeed a novel solution!
And: you just confirmed that the idea is a useful one

If stock prices cannot go negative, than puts cannot have unlimited MaxProfit/MaxLoss. The most a put can be worth is its strike price if a stock can't go below zero. That is a very easy concept to understand and no amount of voodoo math can disprove that fact. For a lognormally price distributed instrument such as a stock, the most a put can be worth is its K, strike price. That is an undisputable fact. For lognormally distributed products, there is no such thing as a put with unlimited risk.

 

[thecoder]

@VolSkewTrader, to summarize:
A fair put algorithm is possible for both normal distribution (where prices can be negative)
as well for lognormally distributed prices (where prices cannot be negative).

Bachelier seems to have developed the one for the normal distributed markets,
and I on the other hand have developed one for the lognormally distributed markets.

I simply feel honored to be among such giants like Bachelier, Black, Scholes, Merton, ...

 

[thecoder]

If stock prices cannot go negative, than puts cannot have unlimited MaxProfit/MaxLoss. The most a put can be worth is its strike price if a stock can't go below zero. That is a very easy concept to understand and no amount of voodoo math can disprove that fact. For a lognormally price distributed instrument such as a stock, the most a put can be worth is its K, strike price. That is an undisputable fact. For lognormally distributed products, there is no such thing as a put with unlimited risk.

As said multiple times: you are simply wrong.
It seems you can't/won't admit that you made a wrong decision in your company...
Maybe you said there that for equal payouts for call and put one needs negative prices. And that decision you seem to be defending blindly since then, even if someone like me proving that it's very well possible also w/o having negative prices. Just applying some psychology here.. .

 

[thecoder]

I currently use a version of the Bachelier model to theoretically price my options in energy products. Even if I raise my IV to 1000% my calls and puts have the exact same delta. I switched from a BSM-based lognormal distribution pricing model to a Bachelier normal distribution pricing model only after WTI crude prices went deeply negative in April of this year. As a result, my puts now have equal payout as the calls...which unfortunately for you, is not possible for stocks and equity indexes.

I have to laugh! All prices, incl. energy prices, are to be treated as lognormally distributed prices.
Therefore, you are simply using the wrong option pricing model!
You have to use the FairPut option pricing model over both Bachelier and also over BSM, to have a mathematical correct model!
The oil barons should just have adjusted the earnings yield % parameter (r) accordingly (ie. making it negative), then they would have avoided negative prices, IMHO. But OTOH, since BSM's put payout is wrong by definition, I can understand that they needed a completely different solution, so they switched to the Bachelier method. But IMO that too isn't correct, much like BSM isn't.

 

[destriero]

@VolSkewTrader, to summarize:
A fair put algorithm is possible for both normal distribution (where prices can be negative)
as well for lognormally distributed prices (where prices cannot be negative).

Bachelier seems to have developed the one for the normal distributed markets,
and I on the other hand have developed one for the lognormally distributed markets.

I simply feel honored to be among such giants like Bachelier, Black, Scholes, Merton, ...

You're an idiot.