Anyone know how to mathematically price an option that has earnings release within 3 months? I know the standard way of finding the average earnings move, fair vol, etc. But how exactly do you price it? Thanks.

Try using the optionslab. You can input volatility and days remaining with current stock price and it will pop you out a price... Free pub for our collegue pengw

The simple answer is use a pricing formula but I suspect you are looking for something more complex. What exactly are you trying to figure out, particularly in terms of a pending EA?

Example: Let's I'm looking at Sep options and FSLR has earnings during that period. I want to generate what a fair value would be based on what I perceive to be the fair vol level based on historical levels and the earnings move I am anticipating. So let's just say 60 and a 10% move for sake of argument.

OK, let's use flsr as an example. The recent ER for fslr is July 30, so the next ER will be more likely around Oct 30, which means you won't see a IV jump for Oct series. Since Oct and Nov series are not listed yet, their IVs are unkown today, see below Aug 72% fact Sep 59% fact Oct 59% very likely Nov ?? a big unknown Dec 59% fact From my experiences, Once Oct become front month, their IV will go up some from 59%, very likely to 72%. And once Nov series began trading, their IVs will start with more than 90% easily due to the ER factor and fact that flsr is a very volatile beast. I have seen flsr's IV go up as high as 190%.

TM, I feel like what Spin said is correct. If you are saying that you think 60 is a fair volatility, you just plug that into a pricing model and get the price then for a given call or put. As far as figuring about a fair volatility, you said you are already aware of how to do that. The other thought would be that if you anticipate a 10% move, you can figure that an ATM straddle should cost about the same as the move expected - if FSLR is about $130, you are saying you expect a move to around $117 or $143 - so in theory a $130 straddle should cost about $1300 to be "fair" for the move you expect at that rate. Of course, it could cost more because of the chance of a much larger move. If you figure a fair ATM straddle price, you could then decide on a fair price for each call/put and then OTM options as welll. JJacksET4

There are a lot of moving parts involved in determining what MIGHT be on a future date. But once you make your major assumptions (time, underlying price and volatility). determining what the option price will be only entails using a pricing formula. You can find them online, use stand alone progrms or import them into your spreadsheet program. Here's one of many: http://www.ivolatility.com/calc/

I think I know what the OP is talking about... In the world of rates, event-based models of vol have evolved to price short-dated stuff. Models that allow you to build a term structure of vol that takes into account NFP and other econ release days, for example. These models evolved because people were picking dealers off (sell the same day straddle, buy the next day one being an example of a simple strategy). I could give you some paper references, but it's normally relatively heavy stuff.

Jacks appreciate the reply. The straddle pricing is very effective but only works for names that have earnings during expiration week. And you can't put it on early in the month, you have to wait till maybe the Thurs or Fri before expiration week begins.

To the OP, you would need to use a stochastic volatility + jump in price and jump in volatility pricing model. If you ask, you can't understand the math involved I guess. Black Scholes with a good volatility estimate is not the answer, you may got on it by luck. Just think that MM are not as clueless as we are. So, the price must be fair and on average, they make money. If your talking about a specific ER on a specific stock at a specific price forget the math and the FV, it's a bet.