Question 1

Why do different options pricing models give different prices for the same option?

Accepted Answer

Each model makes different assumptions about how the underlying moves. Black-Scholes assumes constant volatility and continuous paths, producing a single fair value per option. Heston adds stochastic volatility, capturing the smile that Black-Scholes can't reproduce. Jump-diffusion models (Merton, Kou, Bates) add discontinuous price jumps for event risk. Variance Gamma uses pure-jump Lévy dynamics with explicit fat tails. Local Volatility fits the listed surface exactly by construction. The 'correct' price depends on which assumptions best match the underlying's actual dynamics, and the gap between two models is itself priced information about which assumptions the market is paying for.

Question 2

When should I trust the model prices from an options calculator?

Accepted Answer

Model prices are most reliable for liquid, near-ATM options with 20-60 days to expiration on optionable underlyings with continuous trading and well-defined dividend schedules. Trust degrades for: (a) illiquid options where bid-ask spreads exceed 10% of mid, (b) deep OTM strikes where the smile dominates and model choice matters most, (c) options under one week to expiration where pin risk and discrete dividend effects can dominate, (d) options on underlyings during major events (earnings, FDA, FOMC) where jump risk needs an explicit jump model. The platform's model-divergence view shows where models disagree, which flags the cases that need extra caution.

Question 3

What is the volatility risk premium and why does it persist?

Accepted Answer

The volatility risk premium (VRP) is the gap between implied and realized volatility, typically positive across the equity universe (IV > realized HV by 2-5 percentage points on average). It persists because options sellers bear left-tail risk (losses from unexpected jumps and crashes) and the premium is the compensation buyers pay for that insurance. VRP looks attractive in calm regimes (selling vol carries well) but can disappear or invert during stress events when realized vol spikes above the prior implied level. VRP-based strategies are not free money; they're paid risk premium with a known left-tail.

Question 4

What does the IV term structure tell you?

Accepted Answer

The term structure is the curve of ATM implied volatility across expirations. Contango (longer expirations have higher IV) is the calm-regime norm: the market expects today's vol to mean-revert upward over time. Backwardation (front-month IV above back-month) signals event pricing or stress: an earnings, FDA decision, or macro release is concentrating risk in the near tenor. Steep backwardation usually collapses fast after the catalyst; flat or upward-sloping curves are stable. Reading the term structure shape is a primary input to whether to express a thesis with a calendar spread, a vertical, or an outright.

Question 5

What is gamma exposure (GEX) and why does it matter?

Accepted Answer

Gamma exposure aggregates per-strike gamma across the whole options chain, weighted by open interest and signed by who holds each side. Positive aggregate GEX means dealers are net long gamma: they hedge by selling rallies and buying dips, dampening volatility. Negative GEX means dealers are net short gamma: they hedge by selling dips and buying rallies, amplifying volatility. The GEX flip level (where aggregate GEX crosses zero) is often a regime boundary that materially changes intraday price behavior. Per-ticker GEX views surface these levels with strike-level resolution.

Model Selection by Market Condition