Close to Expiration Option Vol Curve Construction

yyang · August 12th, 2015, 3:41 pm

A common recipe for constructing options vol curves is to use OTM put/call vols, with ATM being the average of put/call vols. This method is generally robust, yet when the option comes close to expiration, put/call vols curves diverge, which causes vols around ATM to look weird. I am sure there is a better way to model close to expiration vol curves but I just don't know it yet. Here is an example.

Alan · August 14th, 2015, 1:17 pm

Interesting chart. The first thing I would do is understand why the apparent ATM conversion arbitrage opportunity fails to bring the implied vols in line.I will guess there is an off-setting bid-ask spread on the underlying (assuming it is tradeable); if so, perhaps that should be taken into account when constructingyour IV curves.

crmorcom · August 17th, 2015, 12:52 am

Are these American or European? And how close to expiration? If you look at C/P parity in price space rather than IV space, how do the differences look? Are they reasonable relative to bid/ask spread? The chart has large enough IV differences that it looks more like a calculation error than transaction costs, but hard to tell without knowing more.

yyang · August 17th, 2015, 6:25 pm

There was a bug in my timestamp parser. Please bury me alive.

ExSan · August 17th, 2015, 8:33 pm

QuoteOriginally posted by: yyangThere was a bug in my timestamp parser. Please bury me alive.next time

crmorcom · August 17th, 2015, 10:09 pm

QuoteOriginally posted by: yyangThere was a bug in my timestamp parser. Please bury me alive.Happens to us all from time-to-time; I just hope you didn't put money on it

yyang · August 18th, 2015, 8:53 pm

QuoteOriginally posted by: crmorcomQuoteOriginally posted by: yyangThere was a bug in my timestamp parser. Please bury me alive.Happens to us all from time-to-time; I just hope you didn't put money on it :)I would never put money on something this weird...