OTM call spreads vs OTM put spreads on very high IV

Maverick74 · Dec 9, 2016

newwurldmn said:
Black scholes assumes arbitrage free pricing which has the cost of financing built into the forward. Today rates are practically zero especially in the context of a high implied vol stock in Jack's example.
If you price a 100 year put under the black scholes model, the put will be worth almost max value (strike price). It's a nuance in the model - Warren Buffet highlighted it as an (flawed in my opinon because his tenors weren't long enough) argument for his infamous put short.

If you have constant vol (under the black scholes framework) all stocks behave like a 2x fund. 100 becomes 101 becomes 99.9, etc. And over a 100 years it will eventually go to zero.

I agree that this part of the model doesn't fit with the reality of the world, but that's why the model shows the greeks it does.
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Yes I should have said the risk free rate is priced into the forward.

JackRab · Dec 9, 2016

No, that's incorrect @newwurldmn, due to forward/future pricing, at very long terms the calls go up and puts down. Basically pushing the strike of the ATM straddle up. Say with spot 100, the 50 year 100-call will have a lot more value than the 100-put due to the interest component which adds to call/lowers put.

You're correct though on the delta behaving like a stock at extremes, because the unlimited upside is more likely at extreme IV.

Maverick74 · Dec 12, 2016

Well...there's your answer. Vol turned out to be cheap. Still a good idea though.

Maverick74 · Dec 12, 2016

So did anyone short this?

JackRab · Dec 13, 2016

No, I didn't get involved yet... I hadn't figured out what I wanted yet. But below 10 was definitely a credible scenario. $30 in the Jan 35 straddle was spot on...

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OTM call spreads vs OTM put spreads on very high IV

Maverick74

JackRab

Maverick74

Maverick74

JackRab