Options  |  AUG 2005

Persistent Option Volatility by Roger Ison, Ph.D.

Stocks & Commodities V. 23:8 (14-20): Persistent Option Volatility by Roger Ison, Ph.D. Do you really understand what your options model is doing? Let’s find out. If you trade options, you know that mathematical option models are essential tools and, generally, very good. Market makers rely on option models explicitly; for example, at least one well-known broker provides tight, mechanically derived, online bid and ask prices for any option, and usually executes trades at their model prices instantly, without human intervention. Brokers’ models can be quite sophisticated, taking into account factors other than the theoretical price, such as the market maker’s current “book,” quotes on other markets, anticipated dividends, recent volatility, and the cost of hedging the market maker’s position with other options or futures. ANALYZING YOUR MODEL It’s a bad idea to trade against that sort of computational firepower without a decent evaluation of the current option prices. It’s also a bad idea to trade without having a clear sense of how your strategy might unfold over time. Excellent modeling software is available to traders, and some usable tools are accessible by web browser, but there are some mistakes traders may make when interpreting these models. In this article, we’ll explore the issue of persistent volatility.

by Roger Ison, Ph.D.