• We are pleased to announce that the winner of our Feedback Prize Draw for the Winter 2024-25 session and winning £150 of gift vouchers is Zhao Liang Tay. Congratulations to Zhao Liang. If you fancy winning £150 worth of gift vouchers (from a major UK store) for the Summer 2025 exam sitting for just a few minutes of your time throughout the session, please see our website at https://www.acted.co.uk/further-info.html?pat=feedback#feedback-prize for more information on how you can make sure your name is included in the draw at the end of the session.
  • Please be advised that the SP1, SP5 and SP7 X1 deadline is the 14th July and not the 17th June as first stated. Please accept out apologies for any confusion caused.

Option Pricing

Matthew H

Keen member
Hi there,

ASET April 2016 Q3i (in the Additional points section) says that "Market-consistent assumptions for the Black-Scholes formula would use risk-free rates observed in the market and market-derived volatilities, eg implied volatilities from other option prices."

Why would the volatility be based on the volatility of other option prices as opposed to the volatility of the assets underlying the unit fund? Or, is the solution saying that we're using the implied volatility baked into option prices as a means of calculating/assuming the volatility of the assets underlying the UF?

Why do we do this, rather than directly calculating the volatility of the underlying? Is it because that calculation would be backwards looking whereas the volatility baked into option prices is forwards looking (and so represents market view -> and so is considered market consistent)?

Thanks,
Matt
 
Hi there,

ASET April 2016 Q3i (in the Additional points section) says that "Market-consistent assumptions for the Black-Scholes formula would use risk-free rates observed in the market and market-derived volatilities, eg implied volatilities from other option prices."

Why would the volatility be based on the volatility of other option prices as opposed to the volatility of the assets underlying the unit fund? Or, is the solution saying that we're using the implied volatility baked into option prices as a means of calculating/assuming the volatility of the assets underlying the UF?

Why do we do this, rather than directly calculating the volatility of the underlying? Is it because that calculation would be backwards looking whereas the volatility baked into option prices is forwards looking (and so represents market view -> and so is considered market consistent)?

Thanks,
Matt
Hi Matt

Yes, it's because that calculation would be backwards looking whereas the volatility baked into option prices is forwards looking and represents the market view and so is considered market consistent.

Best wishes

Mark
 
Back
Top