Negative Prices for Vanilla Options
Date: 2020-07-01

 I identify a third state which should be priced-in b e f o r e buying options,in addition to the two states of ITM (In-the-Money) and AOTM (At or Out-of-theMoney) at exercise in the traditional Option Pricing Theory (OPT). OPT’s two states are more applicable when options are alr e a d y bought. Researchers and practitioners are commonly misled by the zero-payoff-at-worst to believe that vanilla options take non-negative prices only. On the contrary, the third state may lead to negative real payoffs due to heterogeneous unhedged costs of certain options, and to possible negative option prices (NOPs) which are presented with game theory and representative utility function models. NOPs have implications for financial markets and regulations (e.g. option quotes and market-making), and accounting principles (e.g. employee stock options).