Hi, i want to develop an idea - price percentile (or price rank) like the concept of IV Percentile (or IVRank) where we are looking for the current IV, and compare it to the IV of the last year, checking in which percentile the IV is now (high IVR is much more profitable with TastyTrade concepts because High IVR = higher premium to sellers and IV will shrink). i wonder, maybe we can develop a price percentile. the price of the option is generated from several parameters (free interest rate, IV, time to expire, strike price), but at the end the price is the balance between buyers and sellers. maybe some buyers/sellers think that Black–Scholes model is not optimal, and they think that the option is under/over priced or due to the flash crash the put side is more expensive due to fear, whatever the reasons, the price is the price. yes, there will probably be a correlation between high IV and high price. so if we can compare prices between strikes or time to expire (after we normalize it !), we can see that right now the price is very high comparing to other strike or different time to expiration, and then we can decide what to do with it. i want to think with you if we can calculate something that will say that this price is too high/low comparing to prices like him, and maybe we can look for all the prices with the same DTE and with the same distance from ATM, and check the percentile. by the way - we will must normalize the parameters, because we need to get many values to compare with each other. i attached 3 examples - 1. different days before expiration (DTE), the same distance from ATM 2. different dates, the same DTE, the same IV (0.20-0.21), the same distance from ATM 3. the same date, the same DTE, different strikes in #1 i added the theta, so we could use it to normalize the price with the DTE the examples are to show you that the option prices can be high or low regardless the IV, regardless of DTE. what do you think ? Shay
I have no idea what you are going on about ... please reformulate into something that can be clearly (!) understood ...
you have heard about the concept of option skew ? http://www.investopedia.com/terms/v/volatility-skew.asp and that's just a starting remark ...
yes, i know about the skew. it doesn't answer my question, i want to compare 10 point OTM put with other 10 point OTM put at different day and i hope with different DTE, and if i could compare 10 point OTM with 5 points it will be great (although might be difficult due to the skew) i will explain differently - i currently have 7.5 years of historical data of SPY there are 94 occurrences of 24 point away from ATM of put option with 11 DTE so i can do percentile here but i have only 1 occurrence of 10.50 points away from ATM of put option with 31 DTE so i cannot do percentile here (and i cannot compare it with 10 or 11 points without modifications) Shay
I still don't get what you are getting at ... volatility is not the same: it's a changing thing over time like you said: it varies with supply and demand that is guided by fear in the market (option buyers want protection)... so you just can't simply compare vol at different points in time ... 'expensive vol' can get quite more expensive (just look on instances like the nasdaq crash or 2008) ...
you can look at the current IV value, and compare it to the IV of the last year, just to get a sense of how high/low it is. it does NOT says it cannot go even higher/lower, but it will most likely do that (as mean reversion) and as TastyTrade showed again and again, the IV Rank was a game changer for them. entering high IV percentile bring more profits and better PoP. i am trying to think if i could do that with price. Shay
Shay: I have been working on something (for a slightly different purpose), but along the way am producing some insightful info with regard to IV and how it behaves. It may prove useful to you in "normalizing" and being able to more easily observe IV with respect to DTE, Moneyness, and time (by observing the 3-D PUT and CALL Volatility surface as we step from Contango to Backwardation and back to Contango on SPX). If interested, let me know. BTW: You will need "gnuplot", a free plotting program to observe my results.
if you think it so simple as that you most likely have not been very long around the block might be in for a very rude awakening ... sorry to say so but you are playing with fire ... been there done that ...