Option Pricing Via Breakeven Volatility

Financial Analysts Journal, Forthcoming

56 Pages Posted: 11 Oct 2021 Last revised: 10 Jul 2022

See all articles by Blair Hull

Blair Hull

HTAA, LLC

Anlong Li

Hull Tactical Funds

Xiao Qiao

School of Data Science, City University of Hong Kong; Paraconic Technologies US Inc.

Date Written: May 25, 2022

Abstract

The fair value of an option is given by breakeven volatility, the value of implied volatility that sets the profit-and-loss of a delta-hedged option to zero. We calculate breakeven volatility for 400,000 options on the S&P 500 and build a predictive model for these volatilities. A two-stage regression approach captures the majority of observed variation. By providing a link between option characteristics and breakeven volatility, we establish a nonparametric approach of pricing options without the need to specify the underlying price process. We illustrate the economic value of our approach with a simulated trading strategy based on breakeven volatility predictions.

Keywords: options, volatility, prediction, trading strategy

JEL Classification: G10, G11, G13, C14

Suggested Citation

Hull, Blair and Li, Anlong and Qiao, Xiao, Option Pricing Via Breakeven Volatility (May 25, 2022). Financial Analysts Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3938897 or http://dx.doi.org/10.2139/ssrn.3938897

Blair Hull

HTAA, LLC ( email )

141 W. Jackson Street #1650
Chicago, IL 60604
United States

Anlong Li

Hull Tactical Funds ( email )

141 W. Jackson Street #1650
Chicago, IL 60604
United States

Xiao Qiao (Contact Author)

School of Data Science, City University of Hong Kong ( email )

Hong Kong

Paraconic Technologies US Inc. ( email )

New York, NY
United States

HOME PAGE: http://sites.google.com/site/xiaoqiao10/

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