Excellent essay that stands out among the many you have shared with your readers, as it helps explain the background for your repeated writing about applying Black-Scholes to valuation of oil companies so often.
I have some questions.
Do you use actual or implied volatility for the stock price?
If actual, over how long?
What is your view on
a. deciding to buy undervalued (by B/S) options instead of stock options
b. buying the undervalued (by B/S) stock and hedging by selling overvalued (by B/S) options.
Thanks for the many interesting essays you have taken your time to share!
Implied. Actual future volatility is an unknown. Past volatility is not reliable. Options expire, but reserves have lives that are years if not decades. Hedging puts a cap on gains so I don't use hedges very often.
s bids and offers, of course. Yes, it is only a prediction, as are all estimates of the future, including your assumptions about the future value of the oil and gas (US$/$C rates, transport discounts, pipeline availability, etc.). In effect, given that many investors consider future commodity prices, even option buyers/sellers, they tend to have implicit expectations of commodity prices in the term of the option, as you know. This affects their bid and offer prices and therefore the volatility.
Even though your investment time horizon may be longer than those trading longerterm options, in the longterm, we're all dead. And assumptions about future vol and/or commodity prices are always just probability statements. I like your tactics/methodology, but find it closer to using options than you seem to.
I do use options - long term options comprising reserves of commodities. I make no assumption about future prices other than that they are log normally distributed around the current price, an assumption well-supported by many scholarly studies and implicit in the Black Scholes model. The benefit of long duration of reserves as an option is the higher probabiility the commodity price will enter the economically profitable range during the option life, not the case with exchange traded options which typically have durations of less than four years. The market's expectation for future volatilty is embedded in the implicit volatility metric as you correctly state.
Excellent essay that stands out among the many you have shared with your readers, as it helps explain the background for your repeated writing about applying Black-Scholes to valuation of oil companies so often.
I have some questions.
Do you use actual or implied volatility for the stock price?
If actual, over how long?
What is your view on
a. deciding to buy undervalued (by B/S) options instead of stock options
b. buying the undervalued (by B/S) stock and hedging by selling overvalued (by B/S) options.
Thanks for the many interesting essays you have taken your time to share!
Implied. Actual future volatility is an unknown. Past volatility is not reliable. Options expire, but reserves have lives that are years if not decades. Hedging puts a cap on gains so I don't use hedges very often.
"future" vol is the vol caused by the market
s bids and offers, of course. Yes, it is only a prediction, as are all estimates of the future, including your assumptions about the future value of the oil and gas (US$/$C rates, transport discounts, pipeline availability, etc.). In effect, given that many investors consider future commodity prices, even option buyers/sellers, they tend to have implicit expectations of commodity prices in the term of the option, as you know. This affects their bid and offer prices and therefore the volatility.
Even though your investment time horizon may be longer than those trading longerterm options, in the longterm, we're all dead. And assumptions about future vol and/or commodity prices are always just probability statements. I like your tactics/methodology, but find it closer to using options than you seem to.
I do use options - long term options comprising reserves of commodities. I make no assumption about future prices other than that they are log normally distributed around the current price, an assumption well-supported by many scholarly studies and implicit in the Black Scholes model. The benefit of long duration of reserves as an option is the higher probabiility the commodity price will enter the economically profitable range during the option life, not the case with exchange traded options which typically have durations of less than four years. The market's expectation for future volatilty is embedded in the implicit volatility metric as you correctly state.