Financial Risk Manager Part 2
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You are asked to mark to market a book of plain vanilla stock options. The trader is short deep out-of-money options and long at-the-money options. There is a pronounced smile for these options. The trader's bonus increases as the value of his book increases. Which approach should you use to mark the book?
A
Use the implied volatility of at-the-money options because the estimation of the volatility is more reliable.
B
Use the average of the implied volatilities for the traded options for which you have data because all options should have the same implied volatility with Black-Scholes and you don't know which one is the right one.
C
For each option, use the implied volatility of the most similar option traded on the market.
D
Use the historical volatility because doing so corrects for the pricing mistakes in the option market.