Cognitum Option Pricer description

Cognitum Option Pricer estimate the option contract price, using historical price returns distribution. Returns are normalized on local volatility estimate in N-days rolling window.

To calculate an option contract price we need these data:

• Underlying asset historical data for big enough time span. Cognitum Option Pricer will load this data from Yahoo.Finance database.
• Current volatility estimate. We calculate this estimate using the same loaded Yahoo.Finance data.
• Current price of underlying. By default this is the last available price of Yahoo.Finance data. You should be aware that this price is probably delayed for at least 15 minutes. As an option you may set up a connection to TWS and take the last price from TWS.

Having option prices calculated, trader usually want to compare these prices with market prices to see if the contract is overpriced or underpriced. Cognitum Option Pricer can load option chains from either Yahoo.Finance or TWS.

Tickers

• Ticker is the underlying asset. There can be many tickers added into program. The name of a ticker should be the same as in Yahoo.Finance (for example, for S&P 500 index it is “^GSPC”).
• For a ticker there is a starting date, the algorithm uses the data from starting date till last available date. By default all available data is used, but user can change the starting date in order to exclude past data he holds less representative.

By default last price of Yahoo.Finance data is used. User can change the last price source to TWS. To set it up, following contract description info should be set: underlying name, exchange, currency, multiplier and security type. This info is available in TWS: click the contract with right mouse button and select Contract Info / Description.

Option chains
One ticker can have many option chains. Usually, you may want to make one option chain for each expiration date.

A name of an option chain is set by user, any convenient name is allowed.

Creating new option chain, user set data, necessary to calculate the exact time distance before the moment of time when option settlement price is fixed:

• the date when settlement price is fixed;
• the moment when settlement price is fixed (AM for day open, PM for day close);
• number of holidays before the moment when settlement price is fixed.

User also set up option chain strikes: lowest strike, highest strike, strke step and scale (number of digits after the decimal point).

User also set the length of a rolling window used for local volatility estimate. The length of 21 day (a month) suits most cases.

After the chain creation the algorithm tries to calculate model prices for each strike, using historical data. After the calculation is over, you see the data in two tables. Results are recalculated automatically when last price changes or option chain changes.

The upper table has two rows (Sigma, Price) and shows price levels at the moment of option expiration, whose probabilities correspond its sigma (i.e. standard deviation) values.

The main table is self-explaining. When no option chain price source is yet set, only “model price” and “model deltas” columns show data.

Option chain price sources
To compare calculated model results with real market option prices/deltas you have to set option chain source. It can be Yahoo.Finance or TWS.

Yahoo.Finance option chain source

On the Yahoo.Finance ticker page find in the left column the “Options” link, and find necessary expiration month. To set the source up you have to know the code of contract, the starting string in option contract name before “C” or “P” letter. For example, for SPXPM options with 2014-March expiration it will be “SPXPM140322”. Take note, the date in this code may not be the same as the expiration date.

TWS option chain source
To set up TWS option chain you need: underlying name, exchange, currency, multiplier, contract type (option or option-on-futures) and string, representing expiration date. You may find all these data in TWS, click the option contract with the right mouse button and select Contract Info / Description.

TWS connection
TWS connection status is shown under the ticker list.

TWS data sources work only when TWS connection is active. To start the connection, click “TWS status” on the panel or select menu “Settings” / “TWS Settings” and check “Use TWS” and then “OK”.

Option combinations (Combo)
One ticker can hold many combos. You may add to a combo various contracts from various option chains that belong to the same ticker.

Name of the combo is set by user, it can be anything convenient.

Left mouse click on option contract in the main chain table adds this contract to the currently open combo with a weight of +1, or it adds +1 to the weight of the contract if it is already in the combo.

Right mouse click does the same with weight of -1.

Of course, you may edit contract weights in the combo.

An example of Cognitum Option Pricer set up: SPXpm options on S&P 500 index