Hello ,
So I work in asset management, I have a coworker who works as a trader on the financial markets side and he tells me they don’t use black scholes, put call parity, binomial, or anything I have heard of…
What would an options traders use to value an option?
Thanks,
Bjerksund-Stensland model, as it has the benefit of valuing dividend paying securities
And I don’t hedge theta, I collect it.
For publically traded options, I value my options based on bid/ask, and don’t trade illiquid garbage. Market pricing is going to determine the volatility and if you have a different view on volatility than what is implied, you can easily determine if something is under/over valued. I will use Bjerksund-Stensland for scenario analysis and such, but the primarily determinant of my strategy isn’t going to be based on fractional penny arbitrage between the various pricing models.
For OTC options, I’ve primarily used black-scholes (which sucks for equities due to dividends) because it’s easy to model out, but I’ve primarily used structures meant more for hedging than trading, so I’m not extremely dependent on one model vs. the other. Plus, you’re somewhat at the mercy of counterparties for the pricing, so liquidity is going to be a higher determinent of price than the nuances of the various models.
boom! thats deep… put that on my tombstone 
“A valuable contributor to AF lore. But she ran out of theta before she expired. Fortunately, people still liked her dress.”
LOL, solid.
How do you hedge theta? The only way I can think of it is to take a position an offsetting option with the same expiry and moneyness, but usually that will muck up the reason you are doing the original option in the first place, no?
Can you dynamically hedge theta? Say by buying some quantity of the underlying that diminishes the closer you get to expiry?
It can be done statically by neutralizing gamma - dynamically by gamma scalping via shares/options. To your point the only perfect exposure offset is to just not have a position, everything else will carry some basis risk.
Exactly! I ONLY except the premium of value for all the time I am alive. The passage of time is never my liability. Theta power!
Quick read. My take away- middlemen are always on the hussle(not news) and buy potatos right after a nuclear plant melts down, or similar.
for me fundamentals.
http://www.analystforum.com/comment/91618964#comment-91618964
20bucks was the deepest OTM option available at the time. expired well in the money
P&G calls were available with 2% implied volatility when the stock was beat up at $68. it’s now $82. puts were at 35% implied vol.
it’s a lonely place trading stuff like this.
Synthetic long position should be theta hedged no? Buy call, sell put.
I guess. I think of futures as the tool for synthetic longs, but that’s because I’m more of an index guy.
If you don’t have futures but have options, then you can do the buy-call/sell-put options as an alternative. These are similar calendar date and similar moneyness, as I suggested above, so theta is naturally hedged here. You can say “you should hedge theta,” but really the instrument hedges it for you so you don’t have to think much about it.
I was thinking about contexts where you would use the naked option and then try to hedge theta, and how one would try to do that. It seemed tricky to me, which is why I asked.
In a zero sum world, my dream is for my counterparty to follow predictable models.
Most of them do.
Thanks Academia.