Finding Mispriced Options    • 157
to eyeball the ATM volatility for the one- and two-month contracts.
3. If there is a large bid-ask spread, the relevant forward volatility 
to use is equal to the implied volatility we want to transact. In 
other words, use the ask implied volatility if you are thinking 
about gaining exposure and the bid implied volatility if you are 
thinking about accepting exposure (the online application shows 
cones for both the bid implied volatility and the ask implied 
volatility).
Basically, these rules are just saying, “If you want to know what the 
option market is expecting the future price range of a stock to be, find a 
nice, liquid near ATM strike’s implied volatility and use that. ” Most op-
tion trading is done in a tight band around the present ATM mark and for 
expirations from zero to three months out. By looking at the most heavily 
traded implied volatility numbers, we are using the market’s price-discov-
ery function to the fullest. Big announcements sometimes can throw off  
the true volatility picture, which is why we try to avoid gathering infor -
mation from options in these cases (e.g., legal decisions, Food and Drug 
Administration trial decisions, particularly impactful quarterly earnings 
announcements, and so on). 
If I was looking at Oracle, I would probably choose the $32-strike 
options expiring in September. These are the 50-delta options with  
61 days to expiration, and there is not much of a difference between 
calls and puts or between the bid and ask. The August expiration op-
tions look a bit suspicious to me considering that their implied volatility 
is a couple of percentage points below that of the others. It probably 
doesn’t make a big difference which you use, though. We are trying to 
find opportunities that are severely mispriced, not trying to split hairs 
of a couple of percentage points. All things considered, I would prob-
ably use a number somewhere around 22 percent for Oracle’s forward 
volatility.
C12.02 11.75 N/A 55.427% 0.9897 C0.00 0.02 N/A 50.831%- 0.01032011.90
C11.03 10.70 N/A 123.903% 0.9869 C0.01 0.03 N/A 48.233%- 0.01312112.35
C10.04 9.50 N/A 64.054% 0.9834 C0.03 0.05 37.572% 46.993%- 0.01660.012210.10
C0.06 0.04 20.455% 21.147% 0.0463 C5.03 5.55 N/A 36.111%- 0.95584.95370.05
1.65 1.65 22.720% 23.311% 0.6325 0.84 +0.07 0.82 22.989% 23.384%- 0.36790.80311.68-0.13
1.06 1.08 22.019% 22.407% 0.4997 1.23 +0.05 1.25 22.284% 22.672%- 0.50081.23321.10-0.12
0.66 0.65 21.378% 21.813% 0.3606 1.88 +0.16 1.82 21.453% 22.106%- 0.64021.79330.67-0.07
0.02 0.01 21.354% 23.409% 0.0155 C6.99 7.55 N/A 44.342%- 0.98716.85390.02+0.01
0.03 0.01 19.050% 22.144% 0.0266 C6.00 6.30 17.134% 30.947%- 0.97576.15380.030.00
SEP 20 ´13