Expiration Straddle

[boxman]

What's a good way to compute the fair value of the front month straddle? (ie the front month FTSE ATM straddle is currently trading roughly 120 ticks - what's a good way of finding is this should be over/underpriced?

 

[grantx]

Box,

Look at the implieds.

Grant.

 

[luckyd1976]

What's a good way to compute the fair value of the front month straddle? (ie the front month FTSE ATM straddle is currently trading roughly 120 ticks - what's a good way of finding is this should be over/underpriced?

Depending on which platform you're trading. Most have a "Option Pricer" type function.
But if yours doesnt
I googled Black-Sholes and found

BloBek AB - Black-Scholes option value calculator
Hope that helps

 

[grantx]

Box,

Maintain a daily record of implied volatility. You will find this invaluable. LIFFE records the iv for all strikes on its web site for the purposes of SPAN.

Grant.

 

[boxman]

Thnaks guys. But my understanding is that in the final week to expiry the theory goes out the window (to a certain degree) and prices are based more on demand for particular stikes and the ATM's are bought and sold dependant on whether the price of the straddle justifies the potential movement - this was the idea on which I was hoping to gain more clarity.

 

[grantx]

Box,

"the theory goes out the window". That's certainly a good description. For all intents and purposes this may be correct insofar time-value is virtuallly non-existent and therefore, zero implied volatility. OTM's will priced on what mm's can get away with I suppose. However, if the prevailing volatilty is very high, then there will still be a premium to intrinsic.

Prices will (should) still represent non-violation of the arbitrage principle.

Grant.