34 lines
1.6 KiB
Plaintext
34 lines
1.6 KiB
Plaintext
150 • The Intelligent Option Investor
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18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39
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Strike Price
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Oracle (ORCL) Implied Volatility
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Implied Volatility (Percent)
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160
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180
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140
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100
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120
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80
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40
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60
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20
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0
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Thinking about what volatility means with regard to future stock
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prices—namely, that it is a prediction of a range of likely values—it does not
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make sense that options struck at different prices would predict such radi-
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cally different stock price ranges. What the market is saying, in effect, is that it
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expects different things about the likely future range of stock prices depending
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on what option is selected. Clearly, this does not make much sense.
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This “nonsensical” effect is actually proof that practitioners
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understand that the Black-Scholes-Merton model’s (BSM’s) assumptions
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are not correct and specifically that sudden downward jumps in a stock
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price can and do occur more often than would be predicted if returns fol-
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lowed a normal distribution. This effect does occur and even has a name—
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the volatility smile . Although this effect is extremely noticeable when
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graphed in this way, it is not particularly important for the intelligent op-
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tion investing strategies about which I will speak. Probably the most im-
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portant thing to realize is that the pricing on far OTM and far ITM options
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is a little more informal and approximate than for ATM options, so if you
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are thinking about transacting in OTM or ITM options, it is worth looking
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for the best deal available. For example, notice that in the preceding dia-
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gram, the $21-strike implied volatility is actually notably higher than the |