options and fair value.

Discussion in 'Options' started by noob_trad3r, Jan 19, 2010.

  1. If you sell an option and it expires worthless, that means you sold it above fair value correct?

    Since it did not go ITM at the end?
  2. 1) No. It means that it merely expired worthless. It may have been ITM before expiration.
    2) "Fair value" can vary from trader to trader based upon the model(s) that one uses to gauge fair/theoretical value.
    3) OTM options have the value that the market gives them, even though that value WILL be zero at expiration. OTM option premiums cannot be thought of as "free money". :cool:
  3. It depends if you go long an option and it goes down in value and you end up selling at a loss, it sure was not priced fairly in your instance :)
  4. u21c3f6


    Think gambling.

    If you play the seven in craps and win, you win $4 dollars for every dollar wagered. That is below fair value because the true odds are that you will win on average once every six throws of the dice. Therefore fair value for playing the seven requires you to be paid $5 dollars for a win for every dollar wagered. You lose 5 throws at $1 dollar each and you win one throw for $5, net $0 or fair value. (This is a much bigger discussion to include size of wager to bankroll, variance etc., I am just scratching the surface).

    Now assume your casino is feeling generous and offers to pay $6 for every dollar for a win on the seven. You now have the best of the odds or better than fair value. You wager one dollar and a six is thrown, you lose one dollar. The fact that you lost one dollar does not mean that your wager was not better than fair value. You had the best of it, it just didn't hit this time.

    The same holds true for trading. If you have a set-up that "wins" $2 dollars 40% of the time and loses $1 dollar 60% of the time you have an "edge" and I equate that with getting better than fair value for my "wager". Just because one particular "wager" does not pan out it does not mean that your "wager" was less than fair value.

    The reverse also holds true. Just because you win a "wager", it does not mean that your initial "wager" was better than fair value. Think of wagering on the seven and winning $4. The $4 dollars will not be enough to cover the "expected" number of losses if you continue to wager on the seven. Whether or not your set-up is better than fair value can only be determined after many transactions.

  5. sonoma


    Spot on.