Sure, fine, go ahead! Explore your own theory, which you just closed out as being impossible to prove, based on your own science. It's SCIENCE!
I think the dawn means infinite gamma pnl. Ie infinite loss on a short option. This is true but it’s not strictly gamma pnl (it’s a bunch of partial derivatives) and the market makers don’t force it to happen (it happens because a stock moves to practically infinity) and theoretical option pricing accounts for this just fine.
Most of the times someone comes in with their own fantasy theory on options, I get to to learn something new from the traders correcting them, while having a giggle. Thank you!
Gamma being finite has nothing to do with circuit breakers. MissDawn doesn’t understand gamma, thinks models suck, but is constantly quoting model output (gamma).
Oh that’s why the Gamma graph has that shape: that peak is infinity. I remember reading about this in McMillan’s book, “Gamma as an Infinite Investment”.
you price according to the market and use the model as a crutch. You don't trade gamma and vega, you trade an option that is 2$. You need a model to guestimate how much the next up/down strike is as well as the near/far maturity of the same strike. How do you callibrate the model? Well, you look at the most liquid instrument and price every other instrument off of that. In other words, when you look at an FX forward that is quoted 1 pip wide, on the bid is Deutsche and UBS is the offer, you know that the fair price is right in the middle. You plug that price into your model and quote all other forwards accordingly. There is no such thing as a theoretical model that tells you how an option should be priced. You know the ATM vol, you know the 25d calls and puts of the most liquid maturity, you know your forward rate and your interest rate. So if the 25d call is 2$ and the ATM is 8$ how much should the 40 delta trade for? If the 3 month risky trades at 3 vols to the put side, how should you quote the 6 month risky? -> plug it into your model and you have a rough guesstimate. Let's say you quote according to model and you only have one way flow on your quote, then you readjust your quote until you have two way flow...and that is the new price. Adjust all other quotes according to your model
Since you contributed nothing while others were "correcting" me except chiming in with pathetic jokes every once a while, it's time that I block a joke like you so my ET gets better. I am glad I came up with my "fantasy theory" on options, I get a chance to find out who are the real gems on ET and who are just a waste of texts for me to finetune my Ignore/Block list.
So what happens after you get the new price? Does the new price gets fed back into the model to get a new delta, gamma and etc.? Using your example with the 40 delta, after the new price is calculated, doesn't that change the delta of that previous option?