Valuing Commodity Options using Stochastic processes

Discussion in 'Options' started by swoop[TR], May 30, 2004.

  1. Guys,
    Any of you guys use a particular model to incorporate stochastic volatility in models used to value commodity options prices (especially Gold but not limited to).
    I'm not sure which model I should use that would generate decent results. They are OTC options and hence cannot be recalibrated to the market, except for one. I'm using a modified BS model but it keep overvaluing the option. It is very probably due to the use of a static volatility initially calibrated at one delta. It seems we're having a sticky delta kind of problem.
    The Gold market does have a certain skew/leptokurtic distribution.
    Any books or advice?
    Anyone use Jump diffusion techniques, or other models ?
  2. Let me state the obvious.

    When it comes to pit traded commodity options, your best valuation method is the "good old boy system" where you have a great relationship with a pit broker.

    Those guys in the options pits will do special deals with each other, and it is really unlike anything that I have seen in the electronic equities options.

    I understand that I'm not answering your question about theoretical valuation, but I do know that when it comes to pit traded commodity options, options vaulation models go out the window.

    I hope this helps.