Here is what I would consider normative practice.Strive to create a single smooth, euro-style, arbitrage-free, implied-vol smile out of market quotes. As a first step in that, I would collect quotes from exclusively out-of-the-money options with positive bids. In US listed options, the market I am most familiar with, I have yet to see a case where this cannot be sensibly done.If you can show a problem area, please do so, as I don't claim to have seen everything.Trickiest, but still falling under this umbrella, are 'hard-to-borrow' and non-tradable underlyings, which are common. That fitted smile, if correctly translated back to prices (which may be amer-style), typically runs in-between the bid-ask option quotes for both puts and calls, both in-and-out of the money.When that happens, I would say there is no practical error. I am not claiming that no-practical-error always results.But when it doesn't, the most likely explanations are a poor implied-vol fitting procedure and/or a stale quote.
Last edited by Alan
on October 27th, 2014, 11:00 pm, edited 1 time in total.