Dynamic Implied Probability: An Application to 0DTE Options

Key Findings

We developed an innovative approach for pricing options with the Dynamic Implied Probability (DIP) model. The DIP model eliminates the need for differential implied volatilities across strikes. It uses a single implied standard deviation, which tracks the VIX index, simplifying the volatility structure. The model avoids the time decay commonly prescribed in other option pricing models. Implied distributions in the model provide risk-neutral higher moments, enabling more accurate forecasting and simulation of future implied probabilities. DIP is particularly effective for pricing 0DTE options, expiring on the same day they are bought or sold.

Abstract

We take the current market pricing of an option chain for any maturity as given and propose a robust method for simulating and predicting its value at future points in time. The model bypasses traditional option valuation approaches, directly focusing on changes in the implied (risk-neutral) probability distributions of future underlying values. It eliminates the need for differential implied volatilities across strikes, offering a simplified framework. These insights can be used for forecasting option prices, assessing risk, and optimizing trading strategies. The Dynamic Implied Probability (DIP) model is particularly well-suited for 0DTE options, which expire on the same day they are bought or sold.