Option Pricing via Breakeven Volatility

Blair Hull, Anlong Li and Xiao Qiao

Financial Analysts Journal, 2023, vol. 79, issue 1, 99-119

Abstract: The fair value of an option is given by breakeven volatility, the value of implied volatility that sets the profit and loss of a delta-hedged option to zero. We calculate breakeven volatility for 400,000 options on the S&P 500 and build a predictive model for these volatilities. A two-stage regression approach captures the majority of the observed variation. By providing a link between option characteristics and breakeven volatility, we establish a non-parametric approach to pricing options without the need to specify the underlying price process. We illustrate the economic value of our approach with a simulated trading strategy based on breakeven volatility predictions.

Date: 2023
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DOI: 10.1080/0015198X.2022.2100234

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