[RarocASP]

[ QUOTE ]

Just for reference, what dictates option pricing? It's my understanding that a market maker sets prices according to an options pricing model like Black-Scholes and then that price is influenced by supply and demand. I could be way off though, I don't know the inner workings of the options markets.

[/ QUOTE ]

This is a pretty good summary for the purposes of this discussion.

[ QUOTE ]


So, what is to say that the black-scholes model, while applicable to the stock market as a whole, might not over or under-price options for a specific equity/industry?



[/ QUOTE ]

Not all inputs into pricing models are fixed (i.e. future estimates of future underlying volitility, interest rates, ect). Options pricing is determined by the "supply and demand" of varying takes on these variables.

[ QUOTE ]
Or maybe the supply and demand that dictates which way option prices go is skewed one way or the other - either creating returns that are higher than justified or lower than justified - sorta like when the stock market has had periods of relatively low P/E's in the past. Relative option prices wouldn't be affected, but the overall premiums might be off.


[/ QUOTE ]

This absolutely happens, but rarely in very liquid stocks.


Basically, if you are writing a covered call you want stock to go up, but not through your short strike before expiration. If it does, then you would have been better off just owning the stock