GARCH is just one of the methods that some people use. There's no single method for estimating volatility. I think part of the confusion comes from the fact that you use the term "implied volatility" all the time. Once again, the word "implied" is used only when you use market option prices and reverse the pricing model to arrive at volatility number that equates the theoretical price to the current market price. If use GARCH or some other estimation method then you're estimating "future volatility" or "expected volatility" or simply "volatility", but NOT "implied volatility".
if you want to get really deep into options you should read this http://www.amazon.co.uk/Taleb-Risk-...=sr_1_3?ie=UTF8&s=books&qid=1215585097&sr=8-3 but first read something easier like this http://www.amazon.co.uk/Option-Vola...=sr_1_1?ie=UTF8&s=books&qid=1215585158&sr=1-1 and this http://www.amazon.co.uk/Option-Mark...=sr_1_1?ie=UTF8&s=books&qid=1215585181&sr=1-1 Please read up because you obviously know too litle about this subject and this cannot explained in a thread. If those options are really mispriced (although I highly doubt that, markets have become too efficient all over the world during the last 10 years, however it could be possible) you can make a bundle by knowing your theoretical stuff. I made good money arbing options with interactivebrokers just by sitting on the bid and ask in about 20 - 30 options series and delta-hedging them while keeping the greeks into proportion untill three years ago when IB started asking cancellation costs. Don't think that would be possible nowadays with US options as the spreads became too small.
If i correctly understood you to calculate the theoretical price i must estimate 'expected volatility' by any method, not IV....And my problem is a unknowledge about the method's that estimated the expected volatility...If you really calculate by yourself an EV please tell me how you do this...
I am very grateful your for this good books...But don't think that i so stupid in option market.I have geting money from my trading still..Our problem-- the language barier and different concepts...But i wiil solve this problem... I am absolutely assured that the mispriced on your option market-it is a rare situation..
Like I said you can guestemate the future vol. What's even more you can make money trading options if the markets are liquid and you have a big part of the flow without knowing future vol. When I was arbing options I knew more or less wat the vol at that moment was in the market: for example if vol in the first month was around 16 I quoted my bids somewhere around this with a spread of 20 cents. If I started to notice I was getting hit mainly on my asks and getting net short options too big, I started to raise my theoretical prices to 16.5, if it got too extreme I rapidly raised them to 17, if this continued I continued getting up in my theoretical prices untill my overall position in options started to get more flat. This works only in options were there is a good flow. I did at least something like 150 to 200 options a day spread over different strikes and almost never had over 100 delta for longer then a few seconds.
The market where i have trading is not so liquid like CBOE or another options exchange.And for us estimating a theorical price is a really problem. ..as for me it is a good method that you posted above ....But you can make more without risk position if you take the demand of that trader like you then the market is nervous.IMHO...You will not be in time to kill you demand in this case,isn't it? And we measure the delta from 0 to 1... Very hope that i don't deliver you efforts... Thank's for answer...
estimating theoretical price is a problem for everyone: no easy solutions to that one. If you can you can make a fortune. The middle part of your post I don't understand, sorry but the language barier seems to be too big here. As far as I can tell, you think what I told is an extreme situation: it is not, it's the normal eb and flow in volatility of options: it changes all the time and as a (pseudo) market maker you adjust to it if you want to keep on making money. Delta is measured from 0 to 1 but each option has an underlying of 100 shares so this becames 0 to 100.
Okey...I will ask a question in another way..... Did you calculate a expected volatility and put this value in option model to get a theorical price???If yes then tell me please how you estimate an expected volatility...
I didn't calculate it like you think. But I played a different game than you want to play. I only needed an approximate future value to use for my option model. Say I saw the market was more or less pricing in volatility of 16 for all strikes in the front month. I then got my prices for all my strikes which I adjusted for skew, I did this a bit by feel. Say this gave me the following prices for three strikes: 3.51 / 2.29 / 1.43 I then would make a market like 3.40 - 3.60 / 2.20 - 2.40 / 1.35 - 1.55 for something like 20 lots (sometimes 50 on one side, if I was short options too big, I would be heavily bidding and only small offering) and waited untill I got hit. If I got hit I put the number of contracts into my option model which would give me my net deltaposition which I would immediately hedge and look at my overall risk making me to adjust my bids in puts or calls or bid or asks. The hedging was a continous thing. For you what you probabably want to do, the best thing to do is if you think an option is mispriced is calculate implied vol of the option and compare it to implied vol of the other strikes. If the other strikes have more or less the same vol, the option is probably not mispriced but market participants just are estimating a higher / lower future vol than you do. You can try to make money out of that, but like MTE said: are you more clever than they are ? Are you really better at estimating future vol than the market ? If however implied vol of one strike is very much different of vol of other strikes (be carefull however and take skew into account) you can try to do a spread while hedging your delta. Sell the expensie one and buy the cheap one in a delta-neutral ratio and continue to hedge (it's called 'dynamic' hedging for something) afterwards. If you can buy an option at vol 16 and can sell an option in the same month with vol 20 and delta hedge you are bound to make money allmost no matter what happens. Hope this is finally becoming clear to you if it is still not you very urgently have to buy those books.
There's no one best way of estimating volatility. You have to develop one yourself and in order to be able to develop it you need to read up on options (the books cvds16 recommended) to understand what is really going on in the market. For one of my systems I do estimate volatility, but for obvious reasons I can't discuss it.