QuoteOriginally posted by: DocTochow subjective/objective bid/offers are depends on many different things. I would argue that nearly all the time they are subjective as there are too many unknowns to be 100% certain and therefore there is always a degree of finger in the air-ness about making prices. This is what makes making a mkt hard and risky.regarding mid prices are you trying to ask how a mid price in the mkt is established? if so, like I said - mids are irrelevant and only a theoretical construct to make marking a book and analysis easier. Therefore mid can have countless definitions, the most common is probably mid = (bid+ ask) /2, but that is just because it is simple definitely not correct. the only thing that you do know for sure is that the fair value of the asset is some where between the bid and the offer.Your point is quite reasonable from practical point of view. Nevertheless it seemed to me you and other paid to BS price much more attention than (bid+ask) /2 where bid and ask probably might be do not close relate to BS concept. On the other hand if we imagine rather theoretically that option pricing new theory changes benchmark and recommend the price higher or lower than BS it seems that mid price will pull both offer and bid behind up or down?

last attempt now:lets assume that you are talking about vanillas.option pricing models, whether it be BS or SABR or some funky stochastic model do not recommend prices. The market makes the price. models given the same vanilla inputs should give the same price for these instruments. the price comes from the market not from pricing models. for exotics different models give different prices but for standard options it would be a minimum requirement that your model reprices what you put in.

DT from your last attempt it follows that you interpret prices as something that do not admit other price. Nevertheless the commonly used theory interprets prices as a realization of the random process. If we ignore randomness your point is good. Nevertheless in this approach we loss a market risk notion. It is similar to the BS model. BS lost market risk because they talk about BS risk free portfolio and do not pay attention that option price defined by BS portfolio holds the same market risk as another part of the portfolio which is [$]\delta ( t_0 ) * S ( t_0 )[$] over the initial infinitesimal period [[$] t_0 , t_1 [$]].Bearing in mind stochastic setting your framework has somewhat different taste.

I give up sir. I have reached the conclusion that either a) or b) are true.a). I am misguided and definitely don't know enough maths to keep up with the symbols.b). You are misguided.I shall now drink myself silly.I still think having a short stint on a trading floor will help you understand what all of these notions mean in a useful setting.

DT, it is not a big deal when people have different points of view. Sometimes one looks better not because he is right but he can be more experienced to talk 'scientifically'. I am sure that you know enough about stochastic nature of modern pricing but in practice we do not need to remember about it all the time. Actually I appreciate your time and to listen to people that have other experience is always make sense.

QuoteOriginally posted by: list1Once I asked a question about how much institutions use BS methodology for their trades. The question was directed to a person who knows the situation in whole market. It was the answerThe usual view on options markets is that there are 3 types of players1) Retail investors eg you or me2) Institutional investors eg Aegon an insurance company3) Market makers eg Morgan Stanley or CitadelAll 3 types can either buy or sell optionsFor example, a buy write strategy is popular for 1) and 2)1) and 2) never do anything resembling BS hedging. In contrast 3) does do something close to BS hedging. Then it was asked a question If 1), 2) never do something like BS how do then they interpret option price?The answer wasI would say 1) and 2) look at option valuation from an absolute or fundamental perspective whereas 3) look at it from a relative perspectiveThen the question was " if 1), 2) never do something like BS how do then they interpret option price?"and the answer was"So eg if a terrorist is planning on attacking Paris, he might buy puts on a French hotel stock beforehand because he thinks the put price is cheap on an absolute basis.He does not consider combining the long one put with long half a French hotel stock so as to create a portfolio with riskless gains under some strong assumptions like no jumps or only one possible jump size"I do not think that my question regarding "what does happen if market price of the option does not always follow BS pricing model?" completely irrelevant. Even if option pricing follows BSE with calibration or other innovation it makes a theoretical sense to imagine that market pricing can sometimes deviate from BS methodology.Now why do you mention Aegon as an example of 2? Also, your friend is not entirely correct on how optiions are used at insurance comapnies and their asset management arms. Sometimes options or other derivatives are used outright (e.g funds with derivative overlays), but sometimes also used as convexity and volatility hedges, and then the options will be delta hedged.

frolloos, I am not expert in such things you commented. The comment was presented by a high expert. Also I actually first time heard about company Aegon

QuoteOriginally posted by: DocTocI give up sir. I have reached the conclusion that either a) or b) are true.a). I am misguided and definitely don't know enough maths to keep up with the symbols.b). You are misguided.I shall now drink myself silly.I still think having a short stint on a trading floor will help you understand what all of these notions mean in a useful setting.lol

QuoteOriginally posted by: list1frolloos, I am not expert in such things you commented. The comment was presented by a high expert. Also I actually first time heard about company AegonWhy did you quote it?

My point is that not all market participants in real market are using BS price though they take it into account. If they do not use it then the sense of transformation Black vol to Normal one should be specified separately and information of experts who know broad picture of option trading is helpful.

QuoteOriginally posted by: list1My point is that not all market participants in real market are using BS price though they take it into account. If they do not use it then the sense of transformation Black vol to Normal one should be specified separately and information of experts who know broad picture of option trading is helpful.Sorry, but that is not really a point. For simple options we can always make a transformation from a Black vol to a normal vol, but the converse in not true, as those who have recent experience with EUR and/or JPY swaptions can testify (hint: negative strike).

For plain options it is true that one can transform BS volatility in implied vol if normal in title is interpreted as implied, ie the question is quite reasonable. On the other hand we observe only historical data to which we attempt to adjust a model as well as our pricing definitions. My question relates to relationship between theory and practice and it does not eliminates the question itself. For example suppose that other than classical BS model is better approximate option prices or stock price is approximated by a diffusion with jumps.

Apology for my ignorance but what is a normal vol?

normal vol = basis point vol = implied volatility which comes out of a model assuming asset returns are normally (rather than lognormally) distributed.

surely, your belief is driven by whatever b*stardised model you employ that allows you to hedge accurately. You rreally do want to know if you are short gamma when the crash comes!