Professional Documents
Culture Documents
If the digital option is worth more than 0.435, then we do the opposite.
Remark 3.3.4.
Another indication that the Black Scholes model is not suitable, is that
the implied distribution of ST is far from log-normal. That should be a strong
indication that we must seek for other pricing methodologies/formulas.
Often, the estimates from the grid are good enough for what a trader
might need. At large volumes of trading however, a better estimator can
make a huge difference. (For instance, imagine buying 1 million digital op-
tions, the difference between the high and low estimator is 0.1 which would
amount in 100,000 $ maximum loss in the portfolio due to estimation errors).
Remark 3.3.5.
For an investment horizon of T = 1 year and for the given implied
distribution probability a trader could invest in strangle with strikes like
K1 = 90, K2 = 110 or in a straddle with K = 100. The annualized volatility
is high in case of 1 year horizon so there is a high probability of moving
by a large amount in any direction which appeals usually to the strategies
mentioned before.
Remark 3.3.6.
In fact given the data in table 1, one could choose between many invest-
ment strategies in order to benefit from the implied probability distribution
with such fat tails.
11