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 mutluit   Registered: May 2011 Posts: 238 10-29-12 06:53 PM Quote from sle: Yes, barriers are cheaper and there are some simple tricks to understanding if they are good value or not. Hmm, yes, indeed an importantant question & criteria. I must admit I have no clue yet how one could/should do this decision for such barrier exotics, I would like to learn the trick :-) Obviously it must be cheaper than a normal option, the question is how much cheaper?... I think there must be a formula specific for barrier options, isn't it? On the wiki page there are some valuation methods mentioned for barrier options: http://en.wikipedia.org/wiki/Barrier_option#Valuation Edit/Delete • Quote • Complain
 rocky_raccoon   Registered: Mar 2012 Posts: 111 10-29-12 06:53 PM Quote from mutluit: Hmm. I'm not sure if one can see it this way... I would say the maths is correct. Just imagine the last case for itself, ie. see it isolated: the BS formula just gives such a result, and it's correct. So what? If you're a seller and you choose what option to sell: \$3 on the UL or \$.002 on the 2nd degree option, while your potential loss is about the same, which one would you choose? My point is that no one would sell an option for \$.002 if a similar option could be sold for \$3. Of course a buyer would rather buy .002 option but who would sell it to him? Now, if you change IV in the BS formula you would arrive to the values of all tree degrees options to be very close to each other. Edit/Delete • Quote • Complain
 mutluit   Registered: May 2011 Posts: 238 10-29-12 07:05 PM Quote from rocky_raccoon: If you're a seller and you choose what option to sell: \$3 on the UL or \$.002 on the 2nd degree option, while your potential loss is about the same, which one would you choose? My point is that no one would sell an option for \$.002 if a similar option could be sold for \$3. Of course a buyer would rather buy .002 option but who would sell it to him? Now, if you change IV in the BS formula you would arrive to the values of all tree degrees options to be very close to each other. I understand your POV. But following this logic does create arbitrage where it shuldn't... So, something must be wrong, isn't it? And, whether adjusting the IV is the answer, I'm not sure, maybe it really is. Edit/Delete • Quote • Complain
 rocky_raccoon   Registered: Mar 2012 Posts: 111 10-29-12 07:12 PM Quote from mutluit: I understand your POV. But following this logic does create arbitrage where it shuldn't... So, something must be wrong, isn't it? And, whether adjusting the IV is the answer, I'm not sure, maybe it really is. I was just following though on your prices example. It does present an arbitrage opportunity by the way it is calculated. That's why I asked my question. If we remove arbitrage, then all three options will have to have the same price but in this case there is no need for N-th degree options. Edit/Delete • Quote • Complain
 mutluit   Registered: May 2011 Posts: 238 10-29-12 07:32 PM Quote from rocky_raccoon: I was just following though on your prices example. It does present an arbitrage opportunity by the way it is calculated. That's why I asked my question. If we remove arbitrage, then all three options will have to have the same price but in this case there is no need for N-th degree options. Yes, I understand, thx. It's a complicated field, and I'm not a researcher, so I'm shelving these not yet ripe ideas of mine, and instead will take a look at the already existent barrier option products that was mentioned in the other postings. Edit/Delete • Quote • Complain
 rocky_raccoon   Registered: Mar 2012 Posts: 111 10-29-12 07:44 PM Quote from mutluit: Yes, I understand, thx. It's a complicated field, and I'm not a researcher, so I'm shelving these not yet ripe ideas of mine, and instead will take a look at the already existent barrier option products that was mentioned in the other postings. Correct me if I am wrong, but these barrier options look similar to OTM butterflies or condors. In case of OTM condor, UL must trade between inner strikes (similar to barrier condition) for the spread to be profitable. Of course, the spread does not lose value immediately if UL get out of the inner strike range but the overall idea is similar. Edit/Delete • Quote • Complain
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