It sounds like a cliche, but that is why having some sort of a clue what the current volatility relative to past and potentially future volatility is telling you...Obviously, using the Taleb approach and buying catastrophe puts in an extremely oversold market or one with very high levels of implied volatility could be a bad decision...Likewise making a bad guesstimate and selling what you thought was high volatility and then having it spike higher is also a bad decision...But either way each strategy can be adjusted to reduce the odds of complete acct catastophe...
No one has answered my question? Maybe the answer is simply somewhere between a hope and a prayer. For those interested, Paul Wilmott says "The correct statement is that N(d2') is the required probability, where d2' is the usual d2 but with real drift rate instead of risk-free rate.(Having said all that, the error in the estimation of the drift rate is probably bigger than the errors associated with the above mistakes!)." So assuming that we do use the risk free rate of return instead of the seemingly error prone real drift rate the probability of exercise would be N(-d2) = 0.14779857. Hence the odds of JP Morgan coming to near collapse at 10 a share is deemed to be about 1:7. Sound too high, sell it. Sound too low, buy it. This will help my perception of value in options. I hope it will help yours as well.
If you really are any good at pricing in-the-money options, it should not be any problem for you to price out-of-the-money options too. Honestly, if you are trading options, I really do hope you have heard and learned put-call parity. So take your in-the-money options which you apparently know how to price (because they have intrinsic value? I cannot follow the logic here...) and convert them to your out-of-the-money options. ITM call into OTM put, ITM put into OTM call. One of the two always has intrinsic value (except when stock is pinning at the strike), so you can apparently always price any option.
Sounds about right. One strategy is to scan for cheap puts with a couple of days or a week to go. Look for something that is the next strike down trading for about a quarter. The model a lot of people use as well as people looking to salvage any premium causes these things to go for nothing. If the stock crashes through the strike, you make a couple of bucks profit. It is all about risk/reward. If you think JPM will implode in a derivative debacle, .30 looks cheap. It is something which no pricing models can account for. In the idea above, I made decisions based on two factors. One is that the put is dirt cheap in absolute dollar term, 100 lot costs only $2500 bucks. My potential loss is basically the equivalent of one days downdraft in the P/L. This spread out over 3, 4 or a week of trading during which I can do a lot against it. The other thing is what you are ascertain in your posts; what are the odds that the put will go itm? In evaluating this, a trader needs to be realistic about the prospects for the future volaility. This aspect is very stock specific. I focused on the next strike down because it is a realistic in my opinion that the stocks I traded could broach this level. Still, with a stock trading at 39, a 35 strike put is worth .25 on one while a 37 1/2 may only be worth .15 on another with 35 being totally unrealistic(except in this market). It is a feel you develope by studying the market. One thing to look at is the standard deviation of the stock. A $40 stock with a 40 vol has a std dev of $1. What are the odds of this thing going through 37 1/2 or 35 in the next 5 days? 37 1/2 has a reasoanle chance of being breached. I would buy that for a reasonable price.