For keeping track of P/L on thinly traded options ....

Discussion in 'Options' started by dcwriter2, Nov 15, 2019.

  1. should I use the last trade or the halfway point between big and ask or something else?
     
  2. gaussian

    gaussian

    The last trade represents your P&L closest. Using the bid/ask would assume someone would hit the bid or lift the offer, which wouldn't be a great assumption unless you see this happening regularly in whatever you're trading (in which case the last trade would reflect this anyway).
     
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  3. IMO: Using "last" on thinly traded options seems a bad idea, as it could be your own entry, and/or be days old. For liquid options, the MID is recommended, but for thinly traded, you may wish to consider a price that you expect to be able to get filled if you want a pessimistic value. -- What you chose may be more of a function of what you want (pessimistic, or "fair value"). For "fair value", if MID is biased too high or low, you may wish to estimate using nearby strikes to help derive a more realistic value you believe may exist over time. (I do NOT do this, and use MID, but typically trade SPX which has ample liquidity for my strikes)
     
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  4. Matt_ORATS

    Matt_ORATS Sponsor

    For thinly traded options you should use a theoretical value.

    The last trade of an option could have been days away when the stock price was much different.

    Bid-ask quotes are often very wide and meaningless.

    A theoretical value based on a smart smoothing process of the implied volatility is far better than the other two methods.

    At ORATS, we have smoothing that uses historical processes if we score the market quality poorly. This means we use the last minimally acceptable market to get an estimate of implied volatility for and expiration or the entire options chain.

    For example, I looked for a low scoring stock and found ABBV.

    upload_2019-11-15_10-0-9.png

    Let say you were long the Dec 5 calls and short Dec 7 calls.

    · The theoretical value of that spread is $0.02

    · The mid value is $0.00

    · The last value is $0.05 (not shown, Dec 5=0.05, Dec 7 0.00 with no last)

    For theoretical volatility, our summarization process is called Smooth Market Values (SMV) and the smvVol column above is the result. For the Dec 5 the theo vol is 0.388 and 0.389 for the 7s. For reasonableness check the history of the implied volatility and the historical volatility of the stock ex-earnings as in the graph below, the IV has been around 32% and the HV around 30%:

    upload_2019-11-15_10-0-18.png

    Given the theo volatilities proximity to historical IV and HV, you can have some confidence that the theo valuations are reasonable.
     
  5. ironchef

    ironchef

    To be conservative, use bid. On thinly traded, to get out, most of the time you are at the mercy of MM. If your lot size is large, even bid could be too high. How do I know? I trade mostly thinly traded, often time, as @stepandfetchit said, the last trade was mine.
     
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  6. Thanks, guys, lots of good answers here. Mainly this is an issue for me with LEAPS, but when I do my P/L I feel like I have some illiquid BDC or something in front of me that I'm trying to value accurately. I can see how CEFs and some funds get in trouble with this. Anyway, besides signing up for ORATS, anyone know of a good calculator for getting the theoretical value of certain LEAPS? Cheers,
     
  7. .sigma

    .sigma

    The only question that one should ask is.....

    Why on earth is this guy trading illiquid options in the first place?
     
  8. ironchef

    ironchef

    Less competition, same reason why we trade small cap.
     
  9. TheBigShort

    TheBigShort

    Hi Matt, I actually trade in thinly traded options. Would you mind talking a bit more about your approach to smoothing? Currently I fit a local polynomial regression through the mids of the option chain. It works great sometimes but very poorly when the spreads get to wide. I end of having to rely on my broker (these are for stocks that you do not cover).

    In my case I am specifically trying to find where the market believes is fair value. Thanks
     
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  10. What is the degree of your polynomial? Is the fit weighted? How local?

    Are you removing any fly and/or calendar arbs in the mids before fitting the polynomial?
     
    #10     Dec 6, 2019
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