Model or Natural Price Valuation

Last modified 11:53, 5 Nov 2012

Model or Natural Price Valuation

Your SOFTWARE has the ability to perform Trade Valuations using either Model Price or Natural Price.

A simple definition of Model Price is that Your SOFTWARE is internally setup to use a Theoretical pricing algorithm to value each individual option in a trade strategy. There are two models available for theoretical pricing: Black-Scholes or Binomial.

The theoretical Model Price should be used as a general guide to check whether the chosen options being Bought or Sold are Undervalued or Overvalued. For more detailed information on Model Price, see the Option Models topic.

A definition of Natural Price is that option legs are valued using the Bid/Ask spread from the live market. Option legs that have been Bought are valued using the Bid price and options that have been Sold are valued using the Ask price. Valuations using the Natural Price show the actual value of a trade if it was closed out immediately.

It is highly recommended that valuations using Natural Price be selected when analysing potential trades that will be placed into a market. This pricing gives traders an accurate value of what the trade strategy is actually worth in the current market.

Enabling / Disabling Model or Natural Price

Your SOFTWARE has been setup to use either Model or Natural pricing to perform trade valuations. Enabling Model pricing will automatically disable Natural pricing and vice versa. Traders will most likely use Natural Pricing when performing a strategy analysis. This is due to the fact that Natural pricing will show how much the trade strategy is actually worth in the live market.

If the Model Price is being used, it will not reflect what the position is actually worth. Model pricing is mainly used as an analysis tool that can be used to check whether the options being Bought or Sold are Undervalued or Overvalued compared to the actual Bid/Ask prices in the market.

Enabling Natural Pricing Mode

To enable the Natural Price mode, click the Action menu and select Graph Properties from an Option Analysis Strategy tab or Graphs tab page.

Graph Properties Via Strategy Tab

Graph Properties Via Graphs Tab

optanlys_pricing1.png

optanlys_pricing2.png

This will open the Graph Properties screen with focus on the General tab.

optanlys_pricing3.png

Click on the Profit Lines tab and there will be a checkbox setting labelled Draw profit lines using Natural IV. This setting needs to be checked to enable the Natural Pricing mode.

optanlys_pricing4.png

This is a global setting and will ensure that all analysis pricing will be valued using the Natural Bid/Ask spreads and the Risk Graph profit lines will use Natural Volatility in its construction. In addition, enabling Natural Price will automatically disable the Model Price mode.

Enabling Model Pricing Mode

To enable the Model Price mode, uncheck the Draw profit lines using Natural IV setting from the Profit Lines tab in the Graph Properties screen. Enabling Model Price will automatically disable the Natural Price mode.

Recommended Price Valuation Settings

The recommended settings for traders who wish to mark to market their trade strategies are:

  1. Pricing Model   : Black Scholes
  2. Volatility Model : Implied Skew
  3. Pricing Method : Natural

These settings will achieve the fastest pricing performance, the most accurate volatility model to match the market and natural pricing to value trades.

Setting the Option Model

To setup the recommended settings, click the Action menu and select Model from an Option Analysis Strategy tab.

Then set the Option Model parameters as follows:

optanlys_pricing5.png

Enable Natural Price Model

See the section above, Enable Natural Pricing Mode.

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