A bit of a noob question but I'm currently learning how to price options using formulas such as binomial, black scholes, monte carlo etc. My understanding is that these are all methods used to price options to sell. However, if I'm more interesting in only buying/trading call options for the time being, are these formulas relevant?
I mean, I try to calculate them using either historical volatility or Implied volatility but it's more or less the market price when buying calls. I'm a bit confused.
I'm currently only using a paper trading account and trying to gain some experience.
Is Binomial pricing for buying Calls useful?
byu/stepchildzx inoptions
Posted by stepchildzx
7 Comments
Have you done any backtesting, or at least used Google Scholar to look for relevant research?
Very interesting , but outside of a college course, or creating a Video for tastylive what is the purpose ? Also the price of an option is what it trades for, the model can give a price, it is neither for buying or selling just the price using whatever volatility you input. Of course you could put in the trade price and that would give you the volatility for that strike.
Here is an oldie but goodie from Tasty.
Tom Preston http://ontt.tv/2vTPn6m
I would say no the pricing of options is all pretty well known ie. there aren’t any variables your going to enter into the model to find discrepancies the only variable really worth computing is implied volatility which you can calculate to see whether or not the options are overpriced in regard to the volatility that it is priced with. For instance I would look at historical volatility make a judgement call as to whether or not i think it will go up or down considering volatility is usually mean regressing and i will calculate what I believe to be the IV and what the market believes is the IV that is where you will find the best theoretical edge in my humble opinion. And if you are looking into black scholes model I’m sure you know how to calculate volatility.
I would absolutely however, look into if you don’t already use one a program like OptionStrat or marketchameleon for pricing options and visualizing strategies very useful.
Don’t waste your time. The only metric that matters is implied volatility.
In a practical sense, zero.
Think of it this way – the only unknown in an options price is the volatility. Liquidity providers (market makers) along with other institutional entities allocate tremendous resources to forecasting volatility as effectively as possible. All of those market participants then engage in price discovery which yields the prices we see on a day to day. This is where implied volatility comes from (we can IMPLY the market’s forecast of volatility using the black scholes merton model, which is just a differential equation)
Unless you have reason to believe you can effectively forecast volatility more effectively than teams of PhDs whose sole job it is to do so, the pricing models do not matter.
However, from an educational and familiarity standpoint, they’re incredible useful. I’ve built binomial tree, BSM, etc pricing tools simply to learn. I even maintain my own volatility forecast model that I continue to expand simply to be closer to the information and learn. Yet, a trader can go a lifetime simply using implied volatility and be completely fine.
It may be interesting to learn but I wouldn’t say it’s of any use for trading. If you are asking this because you are trying to find the theoretical price of an option to see if it’s over or under valued, you also have to consider what you are plugging in for volatility. Market makers have way way more complex models to create a vol surface than you can find online.