If you want trading secrets for this week, tune into my OP Mentoring session this Thursday as I am just back from vacation today.
If you want to understand how traders came up with options prices, read on.
Pricing in the Old Days
Option pricing prior to the advent of Black-Scholes was a bit more hurly-burly. The
old timers I talked to when I started in the late 80s called it, of course, the good old
Days.
Things like out-of-the-money options staying bid long past their chance of finishing in the
money were relatively common.
Valuing options by pure feel and arithmetic was a great exercise in synthetic relationships. The reversal/conversion, butterfly and box pretty much ruled in the 70s and 80s as the main position management vehicles.
From the beginning, even prior to Black Schole models being available on the trading floor, the one thing that has remained constant was the need to establish some type of relative relationship for liquidity providers.
The advent of the reversal/conversion (R/C), butterfly and box helped traders get a grasp on the pricing of one option relative to the price of another …
After all, at expiration those relationships will move to either parity or expire worthless.
By using synthetic techniques, traders could sell what they thought was the expensive option and bid for the relatively cheaper option and be left with a position with relatively little risk. This allowed some liquidity to form in a particular option class.
This is a trick you can learn in Option Pit Mentoring to help establish option pricing quickly.
To Your Trading Success,
AG