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AnalyticalVega
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How would you price a binary option?

June 9th, 2015, 5:32 pm

Question: How would you price a binary option?1) Start with Plain Vanilla pricing and adjust for binary optionality?2) Use FDM with UVM to price the binary and then hedge against it with Replicated Vanilla Vertical Spreads?3) Use Hybrid Monte Carlo (correction for path dependence) with UVM?4) Use Statistical Pattern recognition with Evolutionary Optimizationto find the historical Temporal Price and Return stability and then predict the future Temporal Price and Return stability use a non-linear curve fitting method such as symbolic regression or polynomial fitting. The probability of future Temporal Price and Return stability would be used as the primary factor in pricing the option?
 
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Orbit
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How would you price a binary option?

June 9th, 2015, 6:16 pm

I suppose I would vote for 1), or Monte Carlo, but 1) is just fine. The greeks will be tradeable and you can always do a bit of "barrier bending" to help as you start to approach pin-risk.
 
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AnalyticalVega
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How would you price a binary option?

June 9th, 2015, 6:49 pm

QuoteOriginally posted by: OrbitI suppose I would vote for 1), or Monte Carlo, but 1) is just fine. The greeks will be tradeable and you can always do a bit of "barrier bending" to help as you start to approach pin-risk.1) is the fastest computationally but I worry about the accuracy especially for 5 and 20 min binary options. 4) is the most accurate but the slowest computationally.
 
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Orbit
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How would you price a binary option?

June 9th, 2015, 8:36 pm

5 and 20 minutes!?
 
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AnalyticalVega
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How would you price a binary option?

June 9th, 2015, 9:31 pm

QuoteOriginally posted by: Orbit5 and 20 minutes!?You don't trade binary options.
 
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Cuchulainn
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How would you price a binary option?

June 10th, 2015, 4:00 pm

Collector (Haug 2007, page 174-...) has formulae for such options. Or The Binomial Approachto Option ValuationGetting Binomial Trees into ShapeStefanie MuelllerFDM with UVM , don't think so if the vol is deterministic.Unless I have missed something, it is fairly tractable problem (?) 3) and 4) look awful far-fetched?? unless you're not sure what the volatility is?
Last edited by Cuchulainn on June 9th, 2015, 10:00 pm, edited 1 time in total.
 
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AnalyticalVega
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How would you price a binary option?

June 11th, 2015, 3:27 am

QuoteOriginally posted by: CuchulainnCollector (Haug 2007, page 174-...) has formulae for such options. Or The Binomial Approachto Option ValuationGetting Binomial Trees into ShapeStefanie MuelllerFDM with UVM , don't think so if the vol is deterministic.Unless I have missed something, it is fairly tractable problem (?) 3) and 4) look awful far-fetched?? unless you're not sure what the volatility is?It is an easy problem to solve, if you know the correct current and future volatility. In the real world we don't know these. UVM is a good way to deal with unknown volatility at a strategic level, but it is not precise enough to use tactically. You need high frequency statistical sampling to get the level of accuracy needed for trading.
 
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Cuchulainn
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How would you price a binary option?

June 11th, 2015, 7:41 am

QuoteUVM is a good way to deal with unknown volatility at a strategic level, but it is not precise enough to use tactically. You need high frequency statistical sampling to get the level of accuracy needed for trading.Rough vol model??
 
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Orbit
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How would you price a binary option?

June 11th, 2015, 7:26 pm

QuoteOriginally posted by: AnalyticalVegaQuoteOriginally posted by: Orbit5 and 20 minutes!?You don't trade binary options.Well not 20 minute durations, that's for sure. If you don't mind me asking, what is the underlying here?
 
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AnalyticalVega
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How would you price a binary option?

June 11th, 2015, 10:56 pm

QuoteOriginally posted by: OrbitQuoteOriginally posted by: AnalyticalVegaQuoteOriginally posted by: Orbit5 and 20 minutes!?You don't trade binary options.Well not 20 minute durations, that's for sure. If you don't mind me asking, what is the underlying here?EUR/USD and ES futures.
 
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AnalyticalVega
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How would you price a binary option?

June 12th, 2015, 10:28 am

QuoteOriginally posted by: CuchulainnQuoteUVM is a good way to deal with unknown volatility at a strategic level, but it is not precise enough to use tactically. You need high frequency statistical sampling to get the level of accuracy needed for trading.Rough vol model??it is a model to predict volatility with a high degree of accuracy over very short time frames. Trade Frequency: 1 - 5 minutesData Sampling Frequency: Tick to minute dataBasically search for repeatable patterns on 10 years of tick, second, and minute data to predict minute patterns in the current market.Compensation for overfitting is done by looking at the behavior of the P&L and Risk metric changes over time and extrapolate with a non-linear curve fitting method. The idea is to predict patterns of minutes of moment stability.
 
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alpher

How would you price a binary option?

July 3rd, 2015, 10:59 am

Aren't binary options the first derivative of vanilla options? Hence: the price of the binary option should follow the same change as the delta of a vanilla, not? Its gamma will be the analogy of delta in ordinary options and so on. So, I'd take your 1: Adjust based on vanilla...In any case: binary options are the closest analogy to betting exchanges. http://betfair.com for pricing :).
 
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DavidJN
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How would you price a binary option?

July 3rd, 2015, 12:24 pm

Pricing is not an issue per se, there are any number of formulations to get that. The real issue from the dealer perspective is hedging. Some good advice heard before on these forums would be that such touchy options are best managed separately from more generic options and that they be given to a directional trader (i.e. a punter).
 
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AnalyticalVega
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How would you price a binary option?

July 5th, 2015, 4:11 pm

QuoteOriginally posted by: DavidJNPricing is not an issue per se, there are any number of formulations to get that. The real issue from the dealer perspective is hedging. Some good advice heard before on these forums would be that such touchy options are best managed separately from more generic options and that they be given to a directional trader (i.e. a punter).you are 50% correct, they are for directional trading, however you still need to price them accurately which means you need a fairly accurate estimate of future (or least current) volatility. Option pricing formulas no matter how goodwon't help you at all if the volatility number you plug in is a bad estimate.