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betting on the inefficiency of the option formula


Guest oilfxpro

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Guest oilfxpro

George sorros quote 

 

Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.

 

The magic formula bets on the unexpected  and returns are like george sorros  below 

 

 

We buy options   , but  the option formula pricing is innefficient.The option formula does not price in volatility of unexpected events

 

examples of unexpected events

 

1)stock market bubble

2)chinese devaluation impact on stock market bubbles bursting

3)greek crisis /financial crisis /euro crisis

4)profit warnings 

5) fraud by corporate companies

6) other unexpected events  like war  ,terrorism   etc

 

if you buy options  , at time of buying options  these unexpected factors are not priced into the option price , option buyers gain when these unexpected events happen , as prices become extremely volatile and unpredictable.

 

Additional edge to beat the option formula can be found in systems designed to beat the formula  , example progressive betting  formulas on the option pricing  models  or systems and combinations of unique option strategies designed to beat the option formula.

 

http://www.investopedia.com/university/options-pricing/black-scholes-model.asp

 

The model makes certain assumptions, including:

  • The options are European and can only be exercised at expiration
  • No dividends are paid out during the life of the option
  • Efficient markets (i.e., market movements cannot be predicted)
  • No commissions
  • The risk-free rate and volatility of the underlying are known and constant
  • Follows a lognormal distribution; that is, returns on the underlying are normally distributed.

The formula, shown in Figure 4, takes the following variables into consideration:

  • Current underlying price
  • Options strike price
  • Time until expiration, expressed as a percent of a year
  • Implied volatility
  • Risk-free interest rates



Read more: Options Pricing: Black-Scholes Model | Investopedia http://www.investopedia.com/university/options-pricing/black-scholes-model.asp#ixzz4ABBQveqQ 
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Guest oilfxpro
Guest oilfxpro

One more factor  not priced into the option formula

 

 

The value of the euro

 

German exports become dearer  and dividends go down  , profit warnings increase  , corporate fraud increases     vv

 

 

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  • 3 months later...
Guest carambar

Hi,

There are few things in your post which are misleading.

The Black scholes option formula is not efficient  as you described, but it's never used as such.

But that's why no one since 1987 use it raw like that.

You will not be able to buy an option on the market priced as such, therefore, there are no inefficiency to take advantage from. Sorry, there are no free lunch ! Only the usual tradeoff risk versus money...

 

What your investopedia link doesn't speak about, is how people really use it. You need to tweak the formula. For example, the volatility is constant under black scholes assumptions, which is wrong on the market. So you use the smile to correct that effect

(https://en.wikipedia.org/wiki/Volatility_smile)

 

Concerning unexpected events, well, the level of the volatility reflects the likeliness of an unexpected event seen by the actors on the market. The value of the options is pricing those events, so again, there is no inefficiency there...(on that matter you could take advantage of the black swann effect if you can hold a position 10 years but that's another story)

 

You can  take advantage of the situation if you can foresee an unexpected event better then everyone else. But then, you are taking risk to be wrong. If you make money , it won't be because option are mispriced, but because you took a risk.

 

so no, options are not inefficient when properly priced, and there are no free lunch 

 

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