How to tell an option is overvalue or not in TOS?

Discussion in 'Options' started by wuming79, Sep 6, 2009.

  1. wuming79



    I come across this software that tells you if an option is overvalue or not. I thought to see if an option is overvalue or not, we can check the IV vs HV in TOS. Is this the correct way to check it?
  2. wayneL


    HV is what has been. IV is what traders think will be. The two values may be quite different without necessarily indicating over/under value.

    Under or overvaluation of is a subjective judgement, unless some option in the chain has been mispriced, but good luck finding something like that.
  3. It may be overvalued relative to it's historical vol, but what if 'high' implied vol is actually warranted? i.e., earnings surprise, legal issues, TARP payback, FDA approval/rejection etc.

  4. If over and undervaluation is subjective, how would a mispriced chain be determined?

    - Ray
  5. MTE


    He was referring to the mispricing of a particular option relative to other options in the chain. Think put/call parity, box spread and jelly roll.
  6. wuming79


    Hi Guys, this is the software that I came across.

    I wonder if we really need such software to tell under or overvalue. I read some articles that we can tell by IV and HV. If that's the case, TOS can plot IV and HV on their charts. We could have look at the 1 year IV and HV to gauge under or overvalue right?
  7. Charlatanism.
    With IV and HV you can tell if an option is cheap or expensive... or very expensive. But overvaluation assume that you know the future. It is trading the volatility and it's not an easy thing. Plot the VIX for 20 years and you will see that a distance from a moving average (hist vol) may not be a holy grail.
    In other words, cheap or expensive is a fact. Overvalued is an opinion.
  8. wuming79, just wondering, do you want to know over/undervalued for event-related forecasting? i.e., undervalued before company earnings report relative to sample of their last 10 earnings reports? (adjusted for VIX).

    Or are you trying to determine over/undervalued of a 'stable' instrument like a broad index?

    One more thing, I have to point out that on the website it says they will have "bonus live tele seminars" and there is a picture of one of those old round dial phones. I mean, really? A professional website would have a better picture at least? Obscure, I know, but that sticks out to me.

    And when I tried to close the website, they hit me with one of those 'stay on the website you can't leave' pop-ups. I hope they didn't just nab me with some spyware? doh.
  9. wuming79



    I just to want to avoid buying expensive options without a hedge on it. Not exactly thinking of getting the software. I read somewhere that IV tend to oscillates between the HV. So I thought when IV s under HV, it was considered as under value and vice verse.

    Guys, how do you measure undervalue and overvalue options? I just shared my thoughts. Just want to see how others do it.
  10. wayneL


    "Expensive" options right now may turn out to have been cheap in a month's time if volatility increases.

    "Cheap" options right now may turn out to have been expensive in a months time if the underlying goes moribund.

    The trader must have an idea of where volatility is going (in other words, guess) before deciding if the current IV is too high or low.

    IV versus HV is a tool people can use in making those projections, and yes volatility *tends* to be mean reverting, but in no way a definitive measure.

    Bear in mind that the current IV is the market's collective opinion of future actual volatility. To make a judgement that the price is mis-valued is betting against the entire market in those options.

    There is noting wrong with that, so long as the risk is understood.

    The clearest example of this is leading up to earnings and announcements:

    IV may start ramping way up above HV if traders believe that the announcement will move the market significantly. However if the markets moves much more than expected, those options premiums will have turned out to have been cheap. Likewise, if the market moves much less than expected, those options were massively overpriced. It's a collective best guess based on available information and a bit of soothsaying.

    Bet against it? Sure, but just like betting on direction, you can get it right or wrong. How much that affects you depends on the strategy you're using, magnitude of move and your actions in managing the position as things develop.
    #10     Sep 7, 2009