Options Premium, Central Limit Theorem, Sampling, and Honesty
Real world quantities, like honesty is projected inclusive of unobserved random events which do not occur in a controlled environment, i.e. cetris paribus. What about options premium?
The central limit theorem is a well-researched by statisticians, whose results agreed that given a sufficiently large number of samples in a population, convergence of the data points will occur within given conditions.
The economist John Maynard Keynes said it is better to be roughly right than precisely wrong. That is why option writers cannot agree on valuation of their option premium. The options premium valuation merely aimed to be roughly right. In my view, the valuation of honesty (or option premium), the requirement for good contained inconsistent assumptions.
Inconsistent Assumptions Affecting Options Premium Valuation
Time does not remain constant, mood changes (systemic and non systemic concerns of the market), respect changes (rotation play, Joseph effect, Noah effect etc), wealth (perceived value, hedging quantity) and health changes (liquidity and hedging requirement).
Options Premium is a form of Honesty Level
The perception of honesty would change. Honesty has a utilitarian purpose for good of society.
Similarly, option premium valuation should have its utilitarian purpose. To the option buyer, the option must be sufficiently good for purchase as a form of hedging or for capital gain. If the option is valued expensive, then there is no apparent utilitarian purpose for the good of portfolio for purpose of purchase.
Looking at honesty, a person who is used to free parking in his home country would be fined for failing to pay for roadside parking via parking meter or failure to obtain a parking permit, etc. Statistics could not differentiate the underlying circumstance as he could fail the honesty test. Honesty is requirement imposed by society. Similarly, the market accepts reasonable options premium.
Level of Honesty is a form of Options Premium
Similarly, options premium valuation is subjected to interrogation by counterparties. If options writer valued his options premium wrongly i.e. unreasonable implied volatility, then intelligent counterparty could arbitrage his way to profitability by manipulating the options premium and underlying assets.
The typical method includes “Box” them in, provided that they are european type options. (See Options 101, Box Spread, Buy a Box, Sell a Box). Bestoptionstradingfordummies.com recommends lack of honesty in options premium with arbitrage.
Look at our Options Trading 101 for basic option trading strategies. Best Options Trading for Dummies profits with sensible Options Premium Valuation. Best options trading for dummies analyse the Central Limit Theorem, Sampling, Honesty and Options Premium.