Trading more volatile stocks made mental pricing calculations riskier and models indispensable

Evidence

As the options markets grew, and the SEC relaxed, options were traded on more stocks, some no longer “blue chip” corporations but instead highly volatile newcomers. More expensive errors made pricing models seem indispensable: “I’ll stand in a pit with [options on] 16 stocks that each trade two [expiration] months and five strike prices and I’ll take anybody on: turn off the lights, I want to trade with no electronics. But when you get to multiple expirations, strike prices, higher volatility stocks … volatility changes by 10 percent. Arco goes from a 15 to a 13.5 [annualized percentage implied volatility]. I can do that math in my head. [With a highly volatile stock] 150 to 135 seems like it ought to be similar, but … I’ve got too much money at risk if I’m wrong in my mental calculations.” — Donald MacKenzie, An Engine, Not a Camera, 750

Categorization

• XREF: Connects to the performativity thesis’ core: models become necessary as markets outgrow traders’ mental capacity, which is a driver of the model-becomes-reality process discussed in earlier chapters. — connects to: The growth and risk of options trading made pricing models indispensable — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 125; Traders’ arbitrage activity made the pricing model appear empirically true — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 126; Traders arbitraging model discrepancies directly improved the model’s econometric test results — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 146 (+1 more)

Broader Connections

• Traders’ arbitrage activity made the pricing model appear empirically true #expands (0.85) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 126
• Traders arbitraging model discrepancies directly improved the model’s econometric test results #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 146