Option Pricing Spreadsheet

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Home of the OC Calculator. Calculator with a Smile chart expanded. For a full screenshot, click here. Beyond the Black-Scholes' model. If you're in the options market, you need a good calculator. The OptionCity Calculator uses two advances from modern option pricing theory: These two ingredients make for a good calculator. Volatility is not constant. If you've traded options, you know that volatility is ever-changing. Click on the thumbnail image to see a long-run chart of the SPX volatility.

For example, you've probably seen this effect: It's sometimes called the "leverage effect" in academic circles. Yet, for option prices to follow the celebrated Black-Scholes' modelvolatility must be a constant -- the leverage effect shouldn't exist.

In a nutshell, there's a contradiction. That contradiction is a key reason why the Black-Scholes' model is often at odds with the marketplace.

In fact, not only does actual volatility jump around over time, but the Black-Scholes' option price calculator free download volatility differs from strike to strike. This is the smile or skew effect. If option prices were determined by the Black-Scholes' model, there would be no smile or skew It would be flat. In reality, you know that as many index options approach expiration, option price calculator free download smile charts become very steep. In other words, out-of-the-money puts trade at very high implied volatilities relative to the at-the-moneys.

Yet the calculator model price, which uses plausible assumptions, is over 8 times higher: Option price calculator free download important, the calculator price is much closer to the market price.

By comparing a similar market price with only the Black-Scholes price, a trader might assume that these puts were grossly over-priced in the market and engage in a systematic selling program. As the calculator shows, that might be a mistake, even though it could indeed prove to be a profitable trading strategy for quite a while. Primarily, the occasional negative jumps about once every 4 years in the screenshotwith the accompanying volatility surge, take back all your profits.

At a minimum, the expected earnings over time are probably much lower than the hypothetical trader expected. This shows how the calculator can save money by reducing mistakes. How the Calculator models work. The option pricing models built into the OptionCity Calculator handle these effects in a realistic way. First, they allow volatility to change; today's volatility is expected to be different tomorrow. Volatility is described by a random process with realistic features.

That's the stochastic volatility part of the Calculator's models. Our stochastic volatility models generate the leverage effect by using a "correlation" parameter. You can see the input slot at the end of the third input row in the screenshot.

The screenshot shows an earlier release. The correlation describes the relationship between stock prices changes and volatility changes.

A negative entry like this means that volatility tends to move up when stock price moves down and vice-versa -- paralleling what you usually see in the equity marketplace! The closer the entry is to For some options, like currency options, there isn't much option price calculator free download a skew the smile is fairly symmetrical. To model this in the calculator, you enter a 0 or very small correlation. What about the very steep skews i.

These skews are often explained by the demand of portfolio hedgers for protection against losses. That's valid as far as it goes, but do the hedgers pay too much?

In the OptionCity Calculator, these skews are generated by two effects that work together. First, there's the correlation leverage effect that we just mentioned. The more negative the option price calculator free download, the steeper the skew.

After all, your puts will become valuable in two different ways. To compensate, sellers have to charge more. How the market moves. But, if you're a portfolio hedger, you will also think about how a option price calculator free download fall might happen.

Hypothetically, if the option price calculator free download was guaranteed to be fairly steady the academics call this a 'continuous sample path'then you can hedge by selling some stock on the way down. Because of this option price calculator free download, you may pay even more for those puts.

Again, the sellers must compensate for the possible jumps, too. Good matches to the market. By including the possibility of negative stock price jumps, the skew charts generated by our calculator become even steeper and very good matches to the market can be achieved. The at-the-money point is about in the chart and the options have about one month to go. So, back to the question: With the OptionCity Calculator, you can translate your own assumptions about jumps and volatility into option price calculator free download prices for options.

Like any calculator, it's a general purpose tool. You provide the input. We do the heavy arithmetic. The models we use are fairly sophisticated, but no model is perfect. We hope you're convinced that ours are closer to reality than some older theories. Try the free download below. The program comes with a Option price calculator free download with more information. The program is a downloadable executable for MS Windows systems.

You validate calculations by selecting a different numerical method:

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