Operator Deep Smoothing for Implied Volatility

Abstract

We devise a novel method for implied volatility smoothing based on neural operators. The goal of implied volatility smoothing is to construct a smooth surface that links the collection of prices observed at a specific instant on a given option market. Such price data arises highly dynamically in ever-changing spatial configurations, which poses a major limitation to foundational machine learning approaches using classical neural networks. While large models in language and image processing deliver breakthrough results on vast corpora of raw data, in financial engineering the generalization from big historical datasets has been hindered by the need for considerable data pre-processing. In particular, implied volatility smoothing has remained an instance-by-instance, hands-on process both for neural network-based and traditional parametric strategies. Our general operator deep smoothing approach, instead, directly maps observed data to smoothed surfaces. We adapt the graph neural operator architecture to do so with high accuracy on ten years of raw intraday S&P 500 options data, using a single set of weights. The trained operator adheres to critical no-arbitrage constraints and is robust with respect to subsampling of inputs (occurring in practice in the context of outlier removal). We provide extensive historical benchmarks and showcase the generalization capability of our approach in a comparison with SVI, an industry standard parametrization for implied volatility. The operator deep smoothing approach thus opens up the use of neural networks on large historical datasets in financial engineering.