Pricing Model

When it comes to determine the fair value of an option you are going to need an option pricing model. Generally these are available through any stock broker. now days of course you can do this all on your own infront of your PC with simple calculators and spreadsheets.
While we need to know the true value of an option by means of a pricing modelwhat is more important to us is how to calculate the probability of the option being a winner for us.
To do this we need to make some assumptions, assumptions that you will not consider during the calculation of the pricing model.
The assumptions are really at the heart of our commodity trading system which is based on using volatility analysis to options trading and looking at the rewards and risk probabilities.

The assumptions are these;
The financial markets are random:
That is that the odds that an asset’s price will go up are identical to the odds that the price will go down.
An asset’s price movement is log normally distributed.

That is, not only is the likely direction -up or down movement-equal, but so is the potential magnitude of the move in logarithmic terms.
This brings us to something we can use. Volatility. Volatility is something we can use. Why is volatility useful to us on the basis of these assumptions?
Volatility coverts a random, log normal distribution into a measure of an underlying asset’s absolute rate of return and risk.
Volatility is able to measure and underlying asset’s absolute price movement.
Now before you go and call your expert maths friend this is in fact easier to understand than you think.
You see the reason why using Volatility analysis in options trading is so effective is because very few people use it, except the wealthy bankers and professional traders. But we will filter this down so that any one can understand the basic concept and use it in options trading.
Now the good thing about these normal distributions are that they have certain properties that allow us to use relatively simple mathematical formulas to calculate probability. Probability is the central principle in our options trading strategy. And it is one that has proved to work year in and year out.
Let us now introduce Standard Deviation, don’t worry really this is easier than you think. Volatility is defined mathematically as one standard deviation of the daily logarithmic price change, annualized.
This is really where an expert trader can easily spot 90 percent of a winning trade.

Pricing Model