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Theoretical value

What a model says an option is worth given the inputs supplied; a benchmark for judging a quote, not an authority on what the option should trade at.

A theoretical value is only as good as the volatility fed into it, and that input is the one thing the model cannot tell you. Quoting a contract as 20 cents under theo means nothing until you say whose volatility assumption produced the theo.

The useful application is relative. Price every line on a chain from one consistent surface and the outliers stand out — a strike whose quote implies a volatility inconsistent with its neighbours is either an opportunity or a sign that your surface is stale.

Example: your surface says the XYZ 45-day $55 call is worth $0.78 and the market shows $0.55 bid, $0.85 ask. The quote straddles your theo, so there is no edge — just a wide market. A $0.95 bid would be a different conversation.

Related: black-scholes-model, mid-price, natural-price, option-liquidity

Educational only, not advice. Spotted an error? Post in Site Feedback.