Undervalued and Overvalued Options

mootw said: "I just discovered your site and have enjoyed reading all the posts. I'm interested in exploring any available resources out there that can both screen for and identify options that are either undervalued or overvalued compared to their historics. Any suggestions?"

drdan said: "Good luck Mootw! Stocks are overvalued/undervalued based on the opinion of the person looking at fundamentals of the company and current events based around that company, so you can have "undervalued or overvalued stocks". With options the price is based on the stock price, so no overvalued or undervalued options are available. There used to be, because options were not as popular as they are now. Once in awhile you would find an option that was priced off from what it should be and you could do something with it, now that just isn't the case. So now you would have to determine based on the stock (overvalued/undervalued) and current or upcoming future events if the option price is over or undervalued. You would use volatility like you want to use option price, compare current or implied volatility to historic volatility."

TippingMonkey said: "I actually quite agree with drdan here. I think to use the words undervalued/overvalued for options can be misleading. Since Implied Volatility is the ultimate driver of option prices (even though it's back-solved using the option's market price), it ultimately comes down to how much risk is implied in the option premium. Higher IV gives you a higher premium, but also means greater risk in the sense that the statistical trading range of the underlying stock is wider (less statistical certainty of landing in the profit zone). Obviously you get potentially "overvalued" options usually right before an important event (earnings, reatil sales numbers, etc.) or right after unexpected movements (convergence theories) where speculation runs wild and the potential trading range for the underlying widens. Is that considered an overvaluation? Perhaps, if you look at the pure monetary value of the option. But really what you are putting up for (or getting) is offset with increased risk you are assuming in taking on the position. At the end of your day, it comes down to your own appetite for risk. - primate [QUOTE=drdan]Good luck Mootw! Stocks are overvalued/undervalued based on the opinion of the person looking at fundamentals of the company and current events based around that company, so you can have "undervalued or overvalued stocks". With options the price is based on the stock price, so no overvalued or undervalued options are available. There used to be, because options were not as popular as they are now. Once in awhile you would find an option that was priced off from what it should be and you could do something with it, now that just isn't the case. So now you would have to determine based on the stock (overvalued/undervalued) and current or upcoming future events if the option price is over or undervalued. You would use volatility like you want to use option price, compare current or implied volatility to historic volatility.[/QUOTE]"