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What Does An Option Pricing Model Tell Us About Opton Prices
What Does An Option Pricing Model Tell Us About Opton Prices
What Does An Option Pricing Model Tell Us About Opton Prices
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Current Issues:
Options
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option, and delta is much less sensitive to these things than theoretical
value. Also, market-makersand active
traders frequently hedge options
against each other, ratherthan against
the stock, so the effects of changing
volatilityand other model inaccuracies
on the different options partly offset
each other. In other words, it may not
matter so much if your model misprices an option as long as the option
will continue to be mispriced in the
same way when the stock price
changes, or as long as it is hedged by
other options that are similarly mispriced.
Still, when a stock has a large price
move, implied volatilities also typically change, meaning that the actual
change in the option's price is not
what was predicted by the original
delta. The skeptic might wonder if we
can even be sure that the apparent
stability of implied volatility under
normal circumstancesisn't partly due
to a kind of self-fulfilling prophecy,
what with so many option tradersusing the model to change their bids and
offers as the stock price moves.
While it was conceived as an arbitrage-based valuation theory, the
Black-Scholesmodel is actually used
by option traders as a pricing equation, to predict how the option price
will change when the underlying stock
moves. But traders treat the model
almost as if it were a rule of thumb,
rather than a formula that gives the
true option value with confidence.
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Footnotes
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