Theoretical option value vs market

[Ian_944]

Hi,

I am new to options and am trying to get my head around their pricing and various strategies. I've started with the pricing, and have been trying to understand pricing on FTSE100 option.

I am trying to use an free Excel option pricing tool I found at hoadley.net (seems like a great tool, FWIW). If you are interested, check it out at http://www.hoadley.net/options/strategymodel.htm

My problem is that the theoretical price I am getting from their calculator is dramatically different to the live prices I have. I would appreciate if anyone could suggest reasons why my theoretical prices are so different from the live prices and point out where I have gone wrong.

So here's the example that has me troubled:

For the live option price, I am looking at TD Waterhouse's option price provided by their spread bet.

FTSE100 level: 5165

FTSE100 June Call, strike price 5075. According to TD Waterhouse: volatility 21.1%, delta 47.3 and the price quote I see is: Sell 253, Buy 257

So, now I use the option calculator I downloaded and set it up as follows:

Risk free Rate: 3.75%
Open to Buy FTSE100 June Call @ 5075, volatility 21.1%, deal expiration 18-June-2010

and the tool gives me a theoretical price for the option of around 320.

Surely I am doing something wrong that I am getting a theoretical price of 320, but the market seems to be at around 250?

Any help on this greatly appreciated!
Ian

 

[Martinghoul]

Something doesn't add up... If the FTSE is at 5165, the TD delta of 47.3 for a 5075 call can't be correct. So it could be that a) the TD system is pricing an option on a FTSE future, rather than the index (Jun FTSE futures are 5073 mid); b) you're reading the TD price wrong.

As to what the problem might be with your calculator, you just need to check your risk-free rate. I think Mervyn King would have a heart attack if you told him that the 4 month money-mkt rate in the UK was 3.75%. If you plug in smth like 0.73%, you'll get something a lot more sensible, I think.

 

[Ian_944]

Something doesn't add up... If the FTSE is at 5165, the TD delta of 47.3 for a 5075 call can't be correct. So it could be that a) the TD system is pricing an option on a FTSE future, rather than the index (Jun FTSE futures are 5073 mid); b) you're reading the TD price wrong.

I see what you mean. It looks like they are pricing the June option off the June future. If I work off the mid-point of the June future, I get the same delta as them +- 0.5

As to what the problem might be with your calculator, you just need to check your risk-free rate. I think Mervyn King would have a heart attack if you told him that the 4 month money-mkt rate in the UK was 3.75%. If you plug in smth like 0.73%, you'll get something a lot more sensible, I think.

Thank you!! That was indeed it, and my pricing is now almost identical to the market quote. I read a definition of risk free money as the rate that gilts trade at, so I plugged in roughly a US 10yr Treasury yield as a starting point.

You have been a great help - thank you!

Ian

 

[convertyourbond]

Yea the delta seems weird.

Just out of interest, why are you doing this? I dont see a way of using this to trade as you are just confirming prices with a theoretical model through a ciruclar argument.