21 lines
1.5 KiB
Plaintext
21 lines
1.5 KiB
Plaintext
The theoretical values, in bold type, are those that don’t line up in the
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middle of the call and put markets. These values are wrong. The call
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theoretical values are too low, and the put theoretical values are too high.
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They are the product of an interest rate that is too low being applied to the
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model. To generate values that are indicative of market prices, Kyle must
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change the interest input to the pricing model to reflect the market’s
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expectations of future interest rate changes.
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Using new values for the interest rate yields the following new values:
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After recalculating, the theoretical values line up in the middle of the call
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and put markets. Using higher interest rates for the longer expirations raises
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the call values and lowers the put values for these months. These interest
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rates were inferred from, or backed out of, the option-market prices by use
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of the option-pricing model. In practice, it may take some trial and error to
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find the correct interest values to use.
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In times of interest rate uncertainty, rho can be an important factor in
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determining which strategy to select. When rates are generally expected to
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continue to rise or fall over time, they are normally priced in to the options,
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as shown in the previous example. When there is no consensus among
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analysts and traders, the rates that are priced in may change as economic
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data are made available. This can cause a revision of option values. In long-
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term options that have higher rhos, this is a bona fide risk. Short-term |