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Option Pricing via Breakeven Volatility

Author

Listed:
  • Blair Hull
  • Anlong Li
  • Xiao Qiao

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 the observed variation. By providing a link between option characteristics and breakeven volatility, we establish a non-parametric approach to 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.

Suggested Citation

  • Blair Hull & Anlong Li & Xiao Qiao, 2023. "Option Pricing via Breakeven Volatility," Financial Analysts Journal, Taylor & Francis Journals, vol. 79(1), pages 99-119, January.
    • Handle: RePEc:taf:ufajxx:v:79:y:2023:i:1:p:99-119
    DOI: 10.1080/0015198X.2022.2100234
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