Why is Fair Value Predictable for Options? But Not Stocks?

Discussion in 'Economics' started by achilles28, Aug 5, 2009.

  1. achilles28


    What makes egg-heads think there's some algorithmic skeleton key that unlocks "fair value" for option prices, but not stocks? Or futures? Or bonds etc?

    All are leveraged instruments traded, in most part, for speculative gains.

    IMO, its a trap. Only fundamental brackets exist - or ranges of fair value - which can be so wide (given the irrationality of markets) to undermine their utility altogether!

    What makes the financial wizkids think they can solve one, but not the other? Isn't it obvious both are solvable or neither are!!
  2. Arbitrage-pricing models to determine fair value exist and are used for all instruments (e.g. for bonds it could be various spread models). In that sense, options, IMHO, are not very different from any other financial instrument. Moreover, I think people do realize that no model is capable of producing a specific fair value for any financial instrument, including options. There's always a notion of confidence interval and error present. Problem is that, as the theory gets more mature and mkt is stable, people start forgetting these notions and get careless.

    To me, option pricing approaches are not different qualitatively. The differences are simply that the theory is a bit newer, so there's a few more holes in it and the mkt participants haven't experienced all the pitfalls yet. Secondly, since option pricing is more complex, there's a few more moving parts and a few more assumptions that need to be satisfied. Finally, as evidenced by the trouble RV funds got into last year, fair value approaches can go horribly wrong even with plain vanilla bonds/equities.

    My Z$2c...
  3. RobtF


    How can you compare? Options are derivatives of course. OPM's take the value of the underlying as a starting point.
  4. Exactly, whereas the underlying has nothing to be valued against like the derivative does.
  5. plenty of folks have models that determine fair value for stocks.

    They are just wrong most of the time.
  6. There's no clear cut fair value for options, either.

    It depends on what the market is willing to pay (premium).

    There's some sort of "fair value" for stocks, depending on interest rates.
  7. Eight


    Minor details...