##### Table of contents

## Option Model

The **Option Model** feature allows users to specify and modify the pricing model that is used to calculate the value of options.

The **Model** feature can be accessed from a number of option-related work-pages in Your SOFTWARE. Click on the model button from a function bar, or choose the **Model...** command in the **Action** menu. The **Option Model** dialog box will open.

In the **Option Model** dialog box select between two **Model** types and adjust a number of parameters for each to customize the preferred pricing model:

Click on an area in the above graphic to go to its explanation below.

From this dialog the pricing model setting for all of the *OptionGear* module's option price calculations can be globally set throughout Your SOFTWARE.

## Model

Your SOFTWARE lets you choose from the two most common pricing models: **Black Scholes** or **Binomial**

Select between them in the drop-down menu:

#### Steps

When **Binomial** is selected, you have the ability to specify the number of steps used to in the calculation. In binomial equations the more steps employed, the more refined the result may be. However, as the steps are increased, greater system resources will be required and performance issues may be encountered depending on the hardware and operating system of each user's PC.

The **Steps** text box is disabled when **Black Scholes** is selected.

#### Style

For **Binomial Models**, users can choose either **European** or **American** style.

American style options can be traded or exercised at any time prior to the expiry date, while European style options can be traded throughout their contract period, but they can only be exercised on the expiry date.

**Black Scholes** only has the **European** style as an option. This is because **Black Scholes** does not take into account dividends or early exercise.

## Volatility Type

Three volatility types can be selected from the **Volatility Type** drop down list:

Each volatility type has its own parameters that will affect the way each of these is calculated.

### Historical Volatility

**Historical Volatility** calculates the average **price movement of the Underlying Security** over a specified period of time, it is not directly affected by the price movements of its derived options.

When **Historical** volatility is selected as the **Volatility Type**, the same percentage volatility level (i.e. that of the underlying security) will display for all the options in the option chain.

Users can set the parameters used in these calculation in the **Historical Volatility Parameters** dialog box. These settings apply to all historical volatility calculations in the *OptionGear* feature set throughout the *software*.

To change the default parameters, select **Historical Volatility** from the **Edit** menu to access its dialog box.

For more information, go to the Historical Volatility Menu Settings topic.

### Implied Volatility

**Implied Volatility** calculates the **price movement of Options** for the same underlying security with the same strike price and expiry date over a specified period of time.

There are a number of different ways to actually calculate Implied Volatility. Each has a number of different parameters, ranges and other settings.

Your SOFTWARE has two Implied Volatility Types: **Implied Average** and **Implied Skew**

### Implied Average

When **Implied Average** is selected, you can choose the type of implied averaging used in the calculation:

#### Auto Bands

The default setting is for **Auto Bands**.

This setting measures the average price movements for all options with the same expiry date and from this calculates the implied volatility. The averaging occurs over the whole range of strike prices.

For example, if the expiry date is within 30 days, the system will calculate the average volatility of all options within 30 days and then compare each individual option to that average. If the option has an expiry date of between 30 and 60 days, its volatility will be compared to the average volatility of all options between 30 and 60 days, and so forth.

#### All Calls and Puts

Choose **All Calls and Puts** to include all option trades for the same strike price and expiry date in the calculation of implied volatility. The Put and Call option series' sharing those strike prices and expiry dates will share the same volatility value.

#### All Calls or All Puts

This is similar to **All Calls and Puts** except that all the trades for each option series, i.e. a **Call** or a **Put** for a particular strike price and expiry date, will be exclusively used in the calculation of its implied volatility.

In this case, each series, regardless of whether it is a **Put** or **Call** option series, will have its implied volatility value calculated separately.

#### Time Defined Settings

The **All Calls and Puts** setting can be restricted to select to only options with expiry dates within specified ranges.

Four settings are available:

- 7 to 30 Day Calls and Puts
- 30 to 60 Day Calls and Puts
- 60 to 90 Day Calls and Puts
- Over 90 Day Calls and Puts

### Implied Skew

When **Implied Skew** is selected, the mid IV (implied volatility) for each option that has a valid bid and ask and volume is used to plot the volatility curve (quadratic/polynomial).

These calculations are used to return different values of volatility for each option.

### Other Volatility Settings

Two other Volatility settings are available in Your SOFTWARE: **Cascade Types** and **Manual Settings**

Check their boxes to apply both, one or neither:

### Use Cascading Volatilities

Check this feature to ensure that if the selected **Volatility Type** cannot find enough data to complete its calculation, for example if there is insufficient bid/ask option data, then Your SOFTWARE will cascade to the next **Volatility Type**.

The cascade is in the following order: **Implied Skew**, if not, then > **Implied Average**, if not, then > **Historical**

**Historical** volatility is the ultimate fallback volatility type because it is based on an average of the underlying security's price data and therefore this type of data is normally always available.

The default setting is checked **On**. This is the recommended setting.

Users should only turn it off if they want to ensure that only a particular Volatility Type was to be used in the calculations. When un-checked, the label is grayed-out.

### Use Manual Volatilities

Occasionally, a user will want to substitute a system generated volatility level with a manually created one, perhaps to test a pricing theory with one of the user’s current strategies, or to correct a known data corruption.

To enter manual volatility values the **Use Manual Volatilities** check-box must be selected in this dialog, and then users can go to the **Manual Volatility** dialog box to enter volatility values for all or some of the options for each security.

#### Manually Entering User Defined Volatility Values

To manually change volatility values for a symbol's options, select a symbol from the work-page and from the **Action** menu or other location, select the **Manual Volatilities** command .

The **Manual Volatility** dialog box displays all the options and their volatility values for all the options for one underlying symbol at a time.

Use the **Manual Volatility** dialog box to select individual options and manually enter volatility values for each, or use the group selection feature to apply new volatility values to large numbers of options.

Refer to the Manual Volatilities Help topic for more details on manually entering volatility values.

After changes are made, click **OK**. The changes will appear in the work-page that you are working in.

## Dividends

**Dividends** paid by the underlying security, and the amount of those dividends, can have an effect on the estimated price (Model price) of options derived from that security.

Some **Option Price Models** use dividend amounts, and in some instances estimated dividend amounts, in their calculations of **Model Price**.

#### Do not Use Dividends

By default, the dividends are not included in the model price:

#### Use Specified Dividends

If you wish to include dividend payments in the model calculation, select **Use Specified Dividends**.

The option model will then use the dividend data entered by the users when it calculates model prices for the options derived from securities which have dividend data available.

#### Enter Dividend Details

In Your Software the amount and payment date of dividends __must be manually entered__ for each underlying security by the user through the **Dividends** tabbed page of the underlying asset's **Detailed Symbol Information** dialog.

For more information, refer to the Detailed Symbol Information topic.

## Related

- OptionGear Screens
- OptionGear Start Page
- OptionGear Strategy Wizard
- Options Analysis Work Page
- Option Graphs
- Volatility Skews
- Options
- Options Analysis
- Analysis Work Page
- Analysis Overview
- Strategies
- Construct Strategies
- Options Filter
- Custom View
- Convert to Trade
- Managing Strategies
- Back Testing Strategies
- Rolling Strategies
- Live Data-on-Demand and Trading
- Risk Graphs
- Using Risk Graphs
- Analysis Palette
- Graph Properties
- Summary
- Summary Work Page
- Weekly Options Analysis
- Weekly Strategies
- Weekly Live Data On Demand Trading
- Option Charts
- Option Graphs
- Option Graph Content
- Page Controls
- Individual Graph Display
- Volatility Charts
- Volatility Overview
- Chart Display
- Using Volatility
- Volatility Skews
- Using Skew Charts
- Fair Value Calculator
- Volatility Calculator
- Model or Natural Price Valuation
- Option Scan Types

## Comments