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# Vol Smile is making me frown

Discussion in 'Options' started by drenaud, May 12, 2010.

1. ### drenaud

I am trying to calculate 'fair value' using the BSM on the ES.

I get it that we don't have all the inputs. We have to guess at the vol. I have seen some people suggest that if you are trading an option that has 60 days to expiration you could use the last 60 days vol as a possible input. (guess)

What has me twisted up is how to apply that to an option that is 50 points away from the current price? I see the implied vol goes from about 20 to 50 very quickly as you chose an option away from the current price. I believe this is this is the vol smile.

So if I want to calculate an estimated value for an option this is 25,50, or 100 points away from the current price how can I get a reasonable vol estimate to plug in?

Thanks for any ideas.

David

2. ### nazzdack

?....Use the option values from similar strike prices in the SPY and SPX.

3. ### MTE

As you have correctly pointed out, getting the right volatility input is the key to getting a meaningful theoretical fair value. Unfortunately, that's the "\$1mil question".

4. ### Martinghoul

\$1mil mine...

5. ### drenaud

Is there some formula or adjustment that can be made to 'convert' ATM implied vol to out of the money implied?

That is if implied ATM is 20% then a call 10% higher should have an implied of X%? Basically accounting for the vol smile.

BTW: Is vol smile the same thing as skew?

Thanks

David

6. ### Martinghoul

"Skew" vs "smile" has to do with the shape. As to quantifying the relationship between ATM and OTM vols, that is also a bazillion \$ question.

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