Pricing Skew/Identifying Mispriced Non-ATM options

[ironchef]

We use a binomial tree approach as described in Haug "The Complete Guide to Option Pricing Formulas".

Thanks.

As an amateur retail, I find neither BSM or binomial tree easy to use going in reverse: using historical option data to compute the greeks eats up lot of computer processing time on my MacBook laptop using excel.

 

[Atikon]

We use a binomial tree approach as described in Haug "The Complete Guide to Option Pricing Formulas".

Do you include 0 DTE Options in your Reports? How are those priced? Especially on 0 DTE Greeks seem to be all over the place at the brokerages, might be useful to have one reliable source to gauge prob/have a correct Delta.

 

[taowave]

Chef, how do you define "amateur" retail??

Thanks.

As an amateur retail, I find neither BSM or binomial tree easy to use going in reverse: using historical option data to compute the greeks eats up lot of computer processing time on my MacBook laptop using excel.

Thanks.

As an amateur retail, I find neither BSM or binomial tree easy to use going in reverse: using historical option data to compute the greeks eats up lot of computer processing time on my MacBook laptop using excel.

 

[Stamamarti]

Do you include 0 DTE Options in your Reports? How are those priced? Especially on 0 DTE Greeks seem to be all over the place at the brokerages, might be useful to have one reliable source to gauge prob/have a correct Delta.

0-DTE pricing is almost like pricing the ‘event-horizon’ ...

 

[Atikon]

0-DTE pricing is almost like pricing the ‘event-horizon’ ...

You mean like binary events? Why do Brokers can't get it done then?

 

[Matt_ORATS]

Do you include 0 DTE Options in your Reports? How are those priced? Especially on 0 DTE Greeks seem to be all over the place at the brokerages, might be useful to have one reliable source to gauge prob/have a correct Delta.

We use percentage of a day starting at 95% at the open and 5% at the close. Pricing models generally don't work with 0 DTE.

 

[VolSkewTrader]

Hi VolSkewTrader
Our method is less of a formula and more of a process.
Strike Slope is a measure of the amount that implied volatility changes for every increase of 10 call delta points within the intra-month skew. It measures how lopsided the 'smile' or 'smirk' is. The derivative is a measure of the rate at which the strike slope changes for every increase of 10 call delta points within the intra-month skew. It measures the curvature of the intra-month skew or 'smile.' We chose just two parameters to describe the skew to get a reasonable fit for the fewest assumptions.
We start with lining up the calls and puts IVs using residual yields. We use the 85 to 15 call deltas in the study. We have more weightings to the call an puts for closeness to the 50 delta and we weight the call vs put the more OTM we go, meaning the 20 delta call IV will get more weighting than the same strike 80 delta put: The IVs will be slightly different even after our residual yield process. Then on to estimating the slope with a best fit, and we are left with errors from the slope line to the actual mid market IVs. We apply the derivative to minimize those errors.

Utilizing your "strike slope" + "derivative" methodology is probably an effective way to generate vol curves for illiquid expirations, or large areas of a smile missing bid/asks. Why don't you just use more reliable OTM IVs vs ITM IVs, which many MM's and mass quoters won't make markets in due to the delta risk?

 

[Stamamarti]

Utilizing your "strike slope" + "derivative" methodology is probably an effective way to generate vol curves for illiquid expirations, or large areas of a smile missing bid/asks. Why don't you just use more reliable OTM IVs vs ITM IVs, which many MM's and mass quoters won't make markets in due to the delta risk?

They do have a reason for this, don't they...?

 

[Matt_ORATS]

Utilizing your "strike slope" + "derivative" methodology is probably an effective way to generate vol curves for illiquid expirations, or large areas of a smile missing bid/asks. Why don't you just use more reliable OTM IVs vs ITM IVs, which many MM's and mass quoters won't make markets in due to the delta risk?

VolSkewTrader
Yes, I should clarify. We create a slope & derivative not to create our smooth market values but to create parameters for comparison to other months in the same security and to other securities.
Our smooth market values process starts with a process akin to a cubic spline and then this spline is adjusted to strike IVs in a localized methodology. This process creates a very accurate theoretical values to the market bid-ask, being in between ~99% of the time.
After the SMV process we then calculate a slope & derivative.
This is an intricate process developed over many years and with much trial and error.
It is a bit tedious to explain but if there is interest and when I have time I can get into the process a bit more.

 

[Atikon]

Utilizing your "strike slope" + "derivative" methodology is probably an effective way to generate vol curves for illiquid expirations, or large areas of a smile missing bid/asks. Why don't you just use more reliable OTM IVs vs ITM IVs, which many MM's and mass quoters won't make markets in due to the delta risk?

If you don't mind sharing, whats a margin of safety you are going with when doing a comparison on IV and you find Volatility worth of Price Discovery in percentage term? 5/10/20% undervalued?