Awhile back I wrote the article How Likely is Oil to Hit 100 Dollars a Barrel in December, 2007? showing how by using the Black-Scholes model, you can calculate through options prices, how likely the market believes a certain event is going to happen. Using the model, a standard one taught in finance classes all over the world, a few months ago I derived an estimate that the probability oil would hit $100 in December was around 2%.
Last week I went backed and looked at the model's predictions and came up with three possibilities:
I guess they'll have to take away my Nobel prize for inventing the Black-Scholes Model, as it might be wrong. As long as I still have my Nobel Prize in Literature for writing Waiting for Godot, I'll be okay.
Note: I see $100 a barrel oil in December as a real possibility (moreso than it was a few months ago). The prediction market Intrade disagrees. According to that market, the probability oil will hit $100.00 a barrel in December is... 2%. (The inTrade contract specifically is whether or not the Feb '08 future will be $100.00 or more on Dec. 31, 2007. So the probability that the price of this future is over $100.00 on any date in December is naturally higher).
In all seriousness, despite my playfully sarcastic tone, I'm really enjoying this back and forth. I'd love to hear your 2 cents!
Last week I went backed and looked at the model's predictions and came up with three possibilities:
- The model is right and oil will not hit $100 a barrel
- The model is right and this is the 1 time out of 50 that oil will reach that level.
- The model is wrong and investors are leaving a ton of money at the table.
I guess they'll have to take away my Nobel prize for inventing the Black-Scholes Model, as it might be wrong. As long as I still have my Nobel Prize in Literature for writing Waiting for Godot, I'll be okay.
Note: I see $100 a barrel oil in December as a real possibility (moreso than it was a few months ago). The prediction market Intrade disagrees. According to that market, the probability oil will hit $100.00 a barrel in December is... 2%. (The inTrade contract specifically is whether or not the Feb '08 future will be $100.00 or more on Dec. 31, 2007. So the probability that the price of this future is over $100.00 on any date in December is naturally higher).
In all seriousness, despite my playfully sarcastic tone, I'm really enjoying this back and forth. I'd love to hear your 2 cents!
Comments
A good rule for any trader is don’t chase. But I’d be buying on a dip after that last inventory report.
I guess you’re right in that it’s not your model, but you seem to endorse its position.
Economists are not as a group at forecasting recessions, trading stocks, or many other things. They tend to believe models when models are by definition imprecise.
If you want to do some interesting work, you should backtest these futures and options’ abilities to forecast future prices, and then, based on past performance, evaluate the likelihood that it is accurate right now.