Bias and its effect on option price.

Discussion in 'Options' started by pod11432, Sep 9, 2010.

  1. pod11432


    Hello, I am curious about an established stock trend and how it effects options. My question is, if there is a strong established uptrend on a stock (call it XYZ), would call options on XZY carry some sort of premium as oppose to another time frame where XYZ is just oscillating and being flat? or even if XYZ is treading now downward? Does the established bias have any role in option pricing? Thanks.
  2. MTE


    A call and a put at the same strike are held together by the put-call parity so a call cannot trade at a premium to a put under normal conditions.
  3. pod11432


    Thanks, so future expectation is not included in the option pricing other than the future expectation of the actual underlying stock, right?
  4. Don't know about stoxx, but in my world these things occasionally might manifest in the shape of the skew. So, as MTE noted, it's not about violating put-call parity, i.e. calls trading at a premium vs puts. It's more about the relationship between the vols for strikes with different moneyness.
  5. MTE


    Whose expectations? Are you assuming that if a stock is in a trend then every market participant would have the same expectations? For each buyer there is a seller.

    Looking at the volatility smile can provide some information in terms of which options are in demand/supply, but even then just because somebody is buying calls and therefore is bidding up the volatility for those calls doesn't necessarily mean that he/she is bullish as you don't know what other positions he/she might hold (EDIT: which is the same thing that Martinghoul mentioned above)
  6. pod11432


    The markets expectation. No I am not assuming that if a stock is in a trend then every market participant would have the same expectations. Rather, I was wondering the way the market prices in future expectations/events on a stock, is it the case for options too? Plus know any book that explains options pricing in detail.

    Thanks for the response, Appreciate it.
  7. MTE


    There are plenty of books on options pricing. The ones that come to mind and are generally considered essential for any beginner are Option volatility & pricing and Options as a strategic investment. I also suggest visiting the books section of ET.
  8. rew


    To the degree that the market prices in future expectations on a stock that stock shouldn't trend. Yes, I know that stocks often do trend. But that shows that the market is imperfect in seeing the future. After all, if everyone believes that some $20 stock is going to trend upward to $30 in 6 months, they'd all jump in immediately and bid it up to say, $28. Thus there would be no trend after all. A trend can only happen because most of the market doesn't believe it will happen at first, and gradually some of the players get converted over time. So trends are funny things, and options are instead priced on the basis of their arbitrage value, which is determined by volatility, not trends.

    This is not so different from futures, which are closely tied to spot prices by arbitrage, regardless of what trends some market players might perceive.