A must read is "Volatility and correlation, the perfect hedger and the fox" by Ricardo Rebonato. Is also treating different underlying(FX,Eqty and IR).

For what manipulation is concerned two decades ago this was way more easy than in nowadays electronic quotation markets and especially if they are liquid option markets.

Thanks! Already starting to look through it and I'm sure many answers will be found within - much appreciated.

In terms of manipulation.... Perhaps not the correct term.... But rather - in theory, for example, could a 'noise' program such as quote stuffing create a reverberation effect into the black-scholes model and result in an increase in I.V.? Can I.V. be artificially high or low based on the degree and intensity of the HFT programs currently battling it out? And, in companies of moderate to below moderate liquidity, is there an I.V. edge via relative options value or would the bid/ask simply swallow it?

Continued: My idea is this: If a predatory HFT program has the ability to model sentiment, generate newsfeed, stuff quotes, and act in a manner that creates chop, which results in a basic reaction of put buying and call writing or vice versa, wouldn't I.V. usually tend to increase to levels where the underlying absolutely would not (more often than not) generate the expected move? Or is this an unrealistic thought, far too simplistic for our markets? I ask primarily because I've seen far too many things I shouldn't have seen in today's day and age of markets - there have been somewhere near 25,000 statistical flash crashes since the original flash crash according to some research I can try and dig up.

IV generally speaking maps to a option price either directly or indirectly (latter being slightly more involved). For options, one finds a spectrum of liquidity in the strike or moneyness dimension and also in the expiration dimension. If you account for the uncertainty in prices via the bid-ask spread, you can clearly see the wide spectrum of possibilities for IV within that. There is obviously a change in the spread due to not just market makers but also other participants' view. HFT folks are quick at digesting and reacting to changes in the market, though not necessarily in the correct fashion in hindsight like everyone else. Keeping this uncertainty in mind, the IV is perceived to change if it is computed using something like midpoint of bid-ask quote as the price spread changes. However, this volatility in implied volatility (IV), is more of a perceived volatility and not really driven by anything fundamental. It’s hepful to distinguish between such dynamics.

In my experience the manipulation mainly kicks in on the underlying to void as many options as possible and yes at times it is clearly manipulated by vested interests and yes IV is often over priced. if you want to debunk manipulation - look at the Yen when the JCB openly admits its pushing yen up (weaker) - and compare with other markets - very similar and very specific behavior can be found everywhere from penny stocks to major commodity futures.

pretty basically all things being equal if someone starts buying up options at ever higher strikes with nothing else changing then mathematically IV will go up. IV is just the parameter which lets you Mark the model to the observable price

so.... a fully hedged option trader who dynamically hedges is simply playing implied volatility they paid vs realized

Good point but the source of gain is already volatile movements.You' ve touched on money maker's effects to prices.It is so simple! If you have more money than other weak participants,you win the game.However, you can compute the standard deviation of options or whatever enstruments from moving avarage of it.Market is dynamic so we cannot know what will happen exactly,only they know and in this case you have to know what decision they have on that enstrument so on.It generally seems like chaotic but actually it is simple due to the decision makers's small amount.Unless you are a member of them, knowledge about the direction cannot be accumulated.On the other hand you can stand on near to MMs.Directions should be estimated according to interval of time.So main purpose is that what strategy will be in decision mechanism

Hi,

Hope you well, very keen to discuss your Implied Volatility project. Please get in touch or provide your contact details.

Regards

Nick

+ 44 78 5260 1993

@Nikhil/Rupert/Daniel - Great point and I believe that distinction is crucial in finding said answers.

Based on how I currently view IV to work, which is very similar to how both Daniel and Rupert explain (with respects to mechanics and manipulation), it comes down to the nature of the options game itself - non-linear position values that are nearly impossible to price for equilibrium, which is caused by the sheer complexity of the market - essentially - options brokers have an incredibly varied clientele (from extreme speculators to extreme hedgers) - and can therefore have large wiggle room when it comes to 'discovering' an equilibrium price. I.V. is mean reverting - but as this is known, prices must discount this - but how? How can brokers prevent all participants from becoming rumour buyers and news sellers? It's probably not their job but rather the job of randomness and unpredictability. (I'm going off tangent here - will continue)

@Sercan - I think I'm following and agree with assertion that buying power is an ultimate edge (although it must be massive, today), and direction cannot be attained by reading into greeks or IV - With regards to options, I really have a hard time believing the brokers know any direction of the underlying - but they must know the direction of overlying. For example - who would have guessed Soros would dump X position on strong news, who would have known HFT's immediately identified it and pulled his sales down to a level that would cause a massive underlying perceptional change in sentiment, which caused excessive options activity and made unusual options activity usual options activity - and therefore giving the brokers an out and the ability to crush the value of most options in both directions, with rising volatility and ATR in the underlying on both short and long term options. This is a real example, by the way. Which leads me to another crucial question: (continued)

IF unusual options buying/selling becomes 'normal', does this effectively drop I.V.?

And, Once I.V. begins it's inevitable drop, do how do options brokers guide options prices? Do option prices begin eroding linearly, relative to the strike and expiration? Or, do certain option values drop more than others (non-linearly) , based on liquidity? Or, could it be random at each strike - based on the random behaviour of speculators? Or a combination of all?

Finally - a previous question re-asked: How does the option broker ensure all participants don't simply become option buyers during the rumour and option sellers after the fact? Are there just that many speculators out there that buy options with crazy high I.V.'s that the edge still exists? I somehow can't really accept that.

Appreciate the insight from you all would like to connect with you as well Nick, thanks for reaching out

I might have just had a real epiphany.

The more options purchased while I.V. is low gives the broker a much larger net short position.

This naturally increases the I.V. - and naturally, as expectations are rarely met when underliers are priced to perfection, disappointment sets in and those long options are sold. However, regardless if the broker is perfectly delta hedged or not going into the event, they can easily eliminate their short position by allowing volatility to crush itself and not offer to buy any back until they are next to worthless.

Simple explanation anyhow

with the implied volatility of options being so low, you have market operators who are using put options, the volatility etf's, volatilty futures and Over the Counter products designed by banks and financial firms to give them downside some inexpensive downside protection of a portfolio's of to use a Finance term "risk assets" including equities, ETF's, high yield debt, bank loans, stock index futures other exchange traded futures and an ocean of other derivatives.

Professional option book makers buy implied volatility when it's low and sell when it's high. They also tend to couple that with delta neutral hedging where they are selling and buying combinations of Options to offset traders who are making outright directional bets on a given stock, stock index, currency, bond etc. And THERE ARE plenty of people, hedge funds and institutions that are doing THAT.