34 lines
2.3 KiB
Plaintext
34 lines
2.3 KiB
Plaintext
Finding Mispriced Options • 151
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$20-strike volatility. If you were interested in buying an ITM call option,
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you would pay less time value for the $20-strike than for the $21-strike op-
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tions—essentially the same investment. I will talk more about the volatility
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smile in the next section when discussing delta.
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In a similar way, sometimes the implied volatility for puts is different
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from the implied volatility for calls struck at the same price. Again, this is
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one of the market frictions that arises in option markets. This effect also
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has investing implications that I will discuss in the chapters detailing dif-
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ferent option investing strategies.
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The last column in this price display is delta , a measure that is so
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important that it deserves its own section—to which we turn now.
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Delta: The Most Useful of the Greeks
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Someone attempting to find out something about options will almost
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certainly hear about how the Greeks are so important. In fact, I think that
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they are so unimportant that I will barely discuss them in this book. If you
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understand how options are priced—and after reading Part I, you do—the
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Greeks are mostly common sense.
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Delta, though, is important enough for intelligent option investors
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to understand with a bit more detail. Delta is the one number that gives
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the probability of a stock being above (for calls) or below (for puts) a given
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strike price at a specific point in time.
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Deltas for calls always carry a positive sign, whereas deltas for puts are
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always negative, so, for instance, a call option on a given stock whose delta is
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exactly 0.50 will have a put delta of −0.50. The call delta of 0.50 means that there
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is a 50 percent chance that the stock will expire above that strike, and the put
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delta of −0.50 means that there is a 50 percent chance that the stock will expire
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below that strike. In fact, this strike demonstrates the technical definition of
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ATM—it is the most likely future price of the stock according to the BSM.
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The reason that delta is so important is that it allows you one way
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of creating the BSM probability cones that you will need to find option
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investment opportunities. Recall that the straight dotted line in our BSM
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cone diagrams meant the statistically most likely future price for the stock.
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The statistically most likely future price for a stock—assuming that stocks |