What would the best model to take advantage of shortcomings in M76 being used to price

Options & Futures
1

What options models would take most advantage of a platforms shortcomings and I was wondering if any fellow Epatians had any experience with Crypto options.  

2

Charlie, could you please elaborate the question?

3

Well the exchange is utilizing m76 to price the crypto options and was wondering if there were any pricing models that would be far superior to utilize to speculate with and form something more accurate. 

4

Hi Charlie,



The TL:DR version of my answer is that there is no definite answer.



Any exchange (crypto or otherwise) does not use any mathematical model to price the options.

The price of the options on the exchange is a result of the market making/order book bid-ask spread.



We as quants on the other hand have various models like the BSM, Black 1975, M76 model and so on.

These models are used to "price" the options so that you, as an analyst/trader know if the asset is overvalued/undervalued. You may use that option pricing in a different, complex strategy as well.



Now comes the question of which model does your asset follow? The practical answer is that it doesn't follow any set model. Rather, you can tweak the models based on your knowledge. For e.g. M76 is essentially Merton's jump component + BSM model.



The goal is to broad base your assumptions for whichever model you are using. Any model you use assumes something. If that assumption holds true, then the option price from the model will be exactly equal to the market price. But this is almost never the case. Why? Because there might be other factors at play that affect the price and your model is not accounting for all of them, or the basic model assumption was violated in the real world market (e.g volatility was non-constant in the BSM model, etc).



So what's the solution?

Use the model/tweak which works best for you!

There is no ready to use out-of-box solution that would accurately work for you for a long time. In perspective, most institutional firms have their own proprietary models, which are closely guarded secrets on not just the type of model, but what parameters they consider and what assumptions it is based on.



Hope this clarifies your doubt!

Thanks,

Gaurav