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There is an interesting rebuttal to the option pricing argument by Zvi Bodie [1] (you can view a free copy via Google Scholar), which I don't claim to fully und
by ctchocula 6y ago
There is an interesting rebuttal to the option pricing argument by Zvi Bodie [1] (you can view a free copy via Google Scholar), which I don't claim to fully understand. Warren Buffett famously sold 15-year European puts in the S&P 500, FTSE, euro stoxx 50, Nikkei 225 and received premiums of $4.5B. To me, it feels like invoking Black-Scholes in this way, Bodie may be making the error of citing a mathematical formula without satisfying all of its assumptions. Perhaps Black-Scholes works for accurately pricing short-term options, but not for 15-year or higher time horizons that more closely match an average adult working career?
[1] On the risk of stocks in the long run: A note. R Taylor, DJ Brown. Financial Analysts Journal, 1996
- exmadscientist 6y agoIt does seem that Black-Scholes cannot apply here. I think the main issue is timing the strike: for a normal option, if it is ever in the money, it will get exercised. For a "portfolio insurance" argument, it seems like we don't really care if the portfolio is down 99.9% for only a single day in the 20 year timespan. But neglecting that possibility would be ruinous to someone underwriting a normal option.
- nyc 6y agoI know very little about finance but I did notice that the author specifically notes that the insurance is the same as an European put option (ie can only be exercised at expiry), to which Black-Scholes can be applied.
- exmadscientist 6y agoI knew that overlooking the word "European" which I did not understand would be a mistake. Thank you.