Reverse Pricing Formula

Quote from Look4aSine:

Many of you have pointed me to Black Scholes and Implied Volitility. Well BS takes me back to wikipedia, ugh. So I decided to re-read some things over the past few days regarding IM, and to me, too many descriptions out there are overly scientific. I want to try to make it simple in my mind, so here's my logic...
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This reminds me of when I first began to learn Spanish (still working on that concept). After DL-ing a bunch of vocab lists from the web, I thot that it might be a lot easier to find a good book. While mucking around Amazon looking for something else, I discovered that the online version of Kindle was free along with the first few chapters of most Kindle books, I could browse for free and try to find one that best suited my noob needs.

So I find this great book that has all kinds of word lists. I figure I'll learn the free stuff and then order the book. After awhile I start doubting myself. Words that I already learned are different. What gives? It takes me a few days to connect the dots. Finally, I read the intro and comprehend that the book was written by someone who decided that there are too many dialects of Spanish so he just made up his own language (can't remember what he called it). Great, Spanish for the world of ONE.

Well, that was a guy who just wanted to make the Spanish word/world simpler in his mind. The problem is, the rest of the world isn't that simple.

Now this story isn't a great analogy. Maybe even long and silly. But the reality is, Black Scholes is a precise formula that deals with the pricing mechanism. So maybe my conclusion is, if you want to rewrite the thing, do it. Put it up on Amazon. Who knows, you might sell 6 copies? But the rest of us are using BS (or other recognized formulas) to do our option pricing. Make the effort to learn the same language and join us :)
 
Quote from Look4aSine:

I'm not looking to rewrite BS.
I'm trying to gain insight into option pricing.

Would my fake-formula be an accurate "description"?
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Accurate? No.

Useful? Sure, for you, weathermen and economists who have predicted 23 of the last 5 recessions.
 
it doesnt look like you know what you're asking for. are you only interested in how much the option has lost in value due to time?
 
Yes.
The Time Value, thank-you.
No one does a good job of breaking it down.
No where in Black Scholes has "X" as the Time Value.
Intrinsic Value is easy to grasp.
 
You are either overthinking it, or you don't know enough yet to ask the right questions.

Assuming a static vol and static underlying, its easy to add in a day or 20 day's worth of theta.

Find an options calculator, enter the option you want to evaluate, then change the days to expiration. It's very simple. With an options calculator, it's also simple to change the vol and underlying to see how the options value would change, if you'd like.
 
I understand that. I just wanted to see if my way of understanding is correct, regardless of word choice.

In my mind, if you buy an option when the Demand Premium is high, then as the stock goes up, the Equity will go up, but the Demand Premium will also go down, which will erase part of the Equity. And, the longer you wait for the stock to go up, the less Per Diem Rent you will be reimbursed when you vacate the position.

Is IV Demand?
 
Quote from Look4aSine:

I understand that. I just wanted to see if my way of understanding is correct, regardless of word choice.

In my mind, if you buy an option when the Demand Premium is high, then as the stock goes up, the Equity will go up, but the Demand Premium will also go down, which will erase part of the Equity. And, the longer you wait for the stock to go up, the less Per Diem Rent you will be reimbursed when you vacate the position.

Is IV Demand?
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No. IV is the expected future volatility which can be different from the past volatility. You can look at time value as per diem rent for your delta exposure but then you will be missing the gamma benefit/cost of your position.

Determining what the demand premium is not clear and it will depend on any model you can develop. It will generally be related to some forecast you make on future volatility.

For what it is worth, there will almost always be some additional risk premium in an option.
 
OK, trying to play in your language...

Quote from Look4aSine:

Is this a correct assessment?

1) Option Price = Intrinsic Value + Time Value

If UL price < strike, there is no intrinsic value. Then it's only time premum

2) Intrinsic Value (a.k.a. Equity) = Underlying Price - Option Strike

Premium components are Intrinsic Value + Extrinsic Value (Time Premium). If the UL Price > than the strike then:

Intrinsic Value = Underlying Price - Option Strike

and

Extrinsic Value = Total Premium - Intrinsic Value

3) Time Value = Per Diem Rent + Economic Value

Time Value is Extrinsic Premium. You can make up any description for what that suits you. Rent, economic value, demand, valuation, widgetability, whatever. It's still TV = Extr Prem

4) Per Diem Rent = ?(Historical Volitility plugged into BS)

Not going there. IV is presently above your pay grade

5) Economic Value = ?(HV - Implied Volitility, a.k.a. Demand)

Oy! Enough already
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Most of this is covered in the first 5 pages of any option book. Try one, you might like it :)
 
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