NEW SPREADSHEET ADD-IN

Local Volatilities/Finite Difference Model

Spreadsheet Add-in

Free 30 Day Trial

Our New Excel Add-in will allow you to:
Forecast the Probability of an Underlying Asset will reach an Expected Level at the Future Date. 
Identify Option Contracts Priced Inconsistently with the Market. 
Hedge Option Positions Consistently with the Current Market Prices. 
Incorporate Multiple Volatilities in the Pricing of Options, i.e. to Incorporate "Hedging Cost" in the Pricing of the Barrier Options. 


What Our New Software Does:
Works with any liquid market, Exchanged Traded or Over-the-Counter 
Calculates "Local Volatilities Surface" from the set of observed option prices on the same underlying asset, but with different expiration dates and strikes. The Local Volatilities Surface allows a trader to use multiple volatilities for pricing and risk management needs. 
Calculates "actual" probabilities of underlying asset reaching set level at future dates. 
Uses Implicit Finite Difference Method to calculate fair values and Greeks of European and American options with or without barriers. Trader can use Local Volatility Surface or provide his own volatility matrix. 


Local Volatilities Surface vs. Implied Volatilities

Multiple Volatilities vs. Single Volatility

A well-known limitation of the Black-Scholes model is that each Implied Volatility represents a single option price. Different Implied Volatilities for options on the same asset creates the Volatility "Smile". 
Market practice is to calculate single implied volatility for pricing and risk management needs. This single volatility is either interpolated from the smile or calculated as an average volatility.

The Local Volatilities Surface allows traders to use multiple volatilities for pricing and risk management needs. Local Volatilities Surface can be used to forecast underlying asset prices at future dates.


Finite Differences Pricing Method

The finite difference approach is one of the major mathematical tools employed to solve partial differential equations. There are two implementation of finite difference method: explicit method and implicit method. Binomial and trinomial pricing models are examples of general explicit finite difference method. In recent years, a number of authors pointed to significant stability and convergence problems while using binomial method to price and hedge barrier options.
Focus Option Calculators and Local Volatilities/Fin Diffs Add-in both offer pricing of options by the Implicit Finite Difference Method which: 

Eliminates "Bumpy" Effect when pricing options with barriers. Calculates accurate and stable fair value for European and American vanilla, single and double barrier options. 
Prices Options Using Multiple Volatilities: Finite Difference Model takes account of the entire Local Volatilities Surface - Available in Focus Option Calculators 

Click here to download working paper describing all details.


To show how it actually works we calculate daily and post on our web site fair values and Local Volatility chart for OEX options.

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