Switzerland
Posts: 112 since Aug 2009
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Hi Jonc
There are mainly two ways of option calculations used in the business:
Black and Scholes Model for European Style Options ( Black?Scholes - Wikipedia, the free encyclopedia )
and the Cox/Ross/Rubinstein model for American Style Options.( Binomial options pricing model - Wikipedia, the free encyclopedia )
Other models like the "Monte Carlo Method " are not very common, at least for the options I trade. ( Please correct me, but I never met any institution or ever had any option software which used MCM as a standard. I use the MC probability calculator some times, but this is a small software by it self )
Edit: I am just told, that Asian Option pricing is many times done with the MCM. Did not know that, as I never trade Asian Options.
May I ask: Do you use any kind of option software ?
If so, check the pricing models in it. There you should be able to choose which one of the above mentioned pricing models you like to use.
If you not have any software, use this link for your calculations: Market Data and there you choose "Pricing Calculators".
Now to your questions:
1. I have some superficial understanding of how options are priced. But am I right to understand that different brokers have different pricing methods and even if they are using the same method, they could have different values for the variables eg volatility when calculating the price?
Answer:
If you trade American Style Options, the broker in general will use the CRR calculation model and if you trade European Style Options, the broker in general will use the B&S calculation model. If you are not sure what kind of option you trade, ask first your broker what you do! To avoid situations where your broker may has an other price compare to the one you have in mind, place limit orders or call him and ask why there is a different between your pricing and her/his pricing.
Depending on the stage you are in any strategy, you may want to go out quickly and then you take the market order. Limit orders are more used for position trading. Disadvantage from limit orders are that you some times wait the whole day for any filled and at the end of the day you are still not filled.
2. How would you calculate the fair price for the options at a point of time when considering the volatility and time factor?
Answer: By considering the volatility and time factor.
Delta_Panther
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