Well, there should be some premium for crash because of the actual crashes that have happened. There should be some risk premium for drawdown resistance. But all this taken together still does not explain the cost of some crash puts, especially in exotic variance space.
That's really interesting. Not quite the same thing, but are you familiar with GNI? That one is a high-dividend trust that is guaranteed to go to zero before much longer. I don't think it's optionable sadly. That would be a case where vol pricing would have a hard time handling terminal dist considerations, especially because it's heading for hard to borrow if it's not already there. This is great stuff -- exactly what I was after when I started the thread. Most of my practice with modeling is econometrics, insurance, and sales/revenue forecasting type stuff -- lots of cases where specialized models can be called for, but time and again basic regressions get you most of the way and are a lot more robust to mis-specification and out of sample stuff that you can't anticipate. I imagine one big benefit of your approach is avoiding overfitting past idiosyncracies in the data.
I would wholeheartedly agree. Exceedingly complex models have all sorts of issues. IMHO, using something simplistic like B-S with full awareness and understanding of its various shortcomings and caveats is infinitely better than some "sausage factory"-type model. That's why, generally, you'd find that in the world of interest rates, which is my home, the most popular models are the simpler intuitive ones. Well, that and the tractability/compute time/etc concerns. I suppose this is all suggesting that there's still nothing out there for these tasks which is as good as the human brain. In terms of crash risks, it's a really interesting issue and, in my mind, it has a lot to do with the leveraged nature of the modern financial system. I would argue that in a mkt where the majority of participants are highly leveraged and mark to mkt, tails should be structurally expensive. Obv, doesn't mean that they can't be significantly overvalued at times.
Martin - If I may ask, how did you end up in the world of interest rates? I am always interested in how people came to be drawn to certain products or working in certain areas. My interest in options, for example, comes from a background in insurance and an academic focus on risk and probability. I initially started learning about options because they offer the most detailed pricing for an entire probability distribution (and/or random process, depending on your perspective).
Pure accident, I assure you... I ended up randomly applying and, what's even more shocking, randomly being hired by a rates desk. Wasn't by any particular design or anything of the sort.
I started in rates and moved into equity derivatives since I was looking for an opportunities in volatility. In terms of number of opportunities, variety of risk premiums and sheer voodoo involved, nothing beats equity derivatives. Rates trading is more about taking delta bets, being a pure vol player is pretty darn hard.
I imagine both are rather capital intensive as well, at least relative to most smaller retail traders. It seems to me that unless you arrange an options trade to be near delta neutral on its own, you basically need portfolio margin to be able to delta hedge a reasonably sized position in any stock above about $20. sle - does that mean you generally are after pure vol trades? I am always curious about how people isolate opportunities. For example, from looking at atticus' old journals, he seems to always be combining vol and delta bets.
you do not need delta, theta,.. volume. nothing. if you have luck,all money is yours. market is full of suckers. I always treat buying options as buying lottery ticket. everyday every hour every minute every second BIG LOTTERY WINNERS are announced. some people try to make sense from non-sense. does volume really mean something?NO. a never traded option strike may be announced, did you see any volume? oh, I never saw it before, who knows how many people are involved into this strike option? Use a formula, you must be kidding. Modelling? what a laugh? ifyou aresceintist, try to lure some funds from the GOV, that is ok. just like those WRAM WEATHER affect scientists, try to warn the GOVER.: the earth temp. is rising because of CO2, we need discover the formula quuickly, otherwise we are toasted? really, we may head into another ICE AGE! I found this winter is particularly long, very cold, my state PA once hit minus -25~-30 in jan.03~jan.04, schools shut down. Natural gas shoot to $6.5! almost double two months ago. my options in UNG net gigantic profits!