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Option Pricing

Option Greeks

A Short Option Pricing Method

If you've no time for Black and Scholes and need a quick estimate for an at-the-money call or put option, here is a simple formula.

Price = (0.4 * Volatility * Square Root(Time Ratio)) * Base Price

Time ratio is the time in years that option has until expiration. So, for a 6 month option take the square root of 0.50 (half a year).

For example: calculate the price of an ATM option (call and put) that has 3 months until expiration. The underlying volatility is 23% and the current stock price is $45.

Answer: = 0.4 * 0.23 * SQRT(.25) * 45

Option Theoretical (approx) = 2.07

 

 

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Peter
Posted Yesterday
Hi Maggie, yes, this formula only works for European options without dividends.

Peter.
Maggie
Posted Yesterday
If I have the the "u,d, possibility(p)" in binomial model, how can I get the volatility for BS? this is a bit academic. thanks
Peter
Posted 194 days ago
Yes, base price = stock (or futures) price.
vishnu
Posted 195 days ago
base price means stock price or other
Joe
Posted 268 days ago
How do you determine the volatitity?
Peter
Posted 351 days ago
The $45 is the underlying stock price...not the market price of the option.

If the market price of the option was $2 then it would be undervalued as the theoretical is higher then what it is trading for in the market.
saurabh
Posted 351 days ago
Thanks Peter.
please correct me, if i am wrong.
Here Theoritical value is 2.07 and the market value is 45, it means that the option is overpriced?? (The market price of the option should be 2.07 but it is 45 actually
please comment
Peter
Posted 352 days ago
Hi Saurabh,

The formula above only works for ATM options...not for a specific strike.

If you want a pricing model in Excel click on the Free Spreadsheet link above.
saurabh
Posted 352 days ago
or how do we use this to find out the strike price we add this to present market price???
saurabh
Posted 352 days ago
PLEASE explain me the meaning of this 2.07. how do we use this to find out ITM or OTM
Admin
Posted 428 days ago
It's because this is for calculating an ATM option. The strike price is the same as the base price.
Chris
Posted 428 days ago
I don't see any mention of the Strike price.
PhilTheGreek
Posted 544 days ago
This is a result from Black-Scholes equation S*N(d1)-K*N(d2) assuming zero interest rate and setting S=K, gives S*{N[+0.5*volatility*sqrt(time)]-N[-0.5*volatility*sqrt(time)]} which is S*volatility*sqrt(time)/sqrt(2*pi) and 0.4 is 1/sqrt(2*pi).
adrian
Posted 554 days ago
would the base price in this case be $45 ?