Closing an ITM option position - disregard midpoint and base on intrinsic value?

ironchef said:
I don't quite understand your situation, did you sell at market? Otherwise why did you offer $1.92 when the intrinsic value was $2.32?
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I closed out by selling between bid and midpoint (bid was 1.71 and I sold at 1.92 via limit order). I didn't sell around intrinsic because I didn't know better and was just operating in "get in the spread" mindset, but afterwards when I saw what happened it got me thinking.

ironchef said:
Usually when there is time remaining, you can ask to sell close to intrinsic. When I closed out ITM options I was always able to get slightly above/around intrinsic value unless the underlying was going to make a significant move which I did not know but apparently the MM knew. In those cases my limit orders did not get executed but always the stocks made a move soon to reflect the new situation.
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Okay, good to know - this is the type of answer I was looking for. Do you usually just add a few cents to intrinsic in setting your price?
 
trade-9 said:
s there a formula you recommend using in determining how to value it? Should you never sell for more than a few cents lower than the intrinsic value for example, unless fast moving underlying?
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It would help to have a platform that provides fair value based on current or your own option skew. If you don't have that, you can use put/call parity as a basis. For an ITM call, parity + the put value. It will not be "accurate, but a close approximation. eg:

Stock 100
Long the 80 call
Put value $0.25

Call is worth "about" 20+.25 or $20.25

Interest rates and dividends will have to be taken into account to be more accurate. And, it is OK to give up a little to fair value to exit or enter a trade. Cost of doing business. For options that have wide bid/ask spreads, never assume the mid point has meaning. eg

current option market from 80 call above: 19.50/21.50
we have said it is worth about 20.25 even though the midpoint is 20.50. If you try and sell your options at 20.75, the new market is 19.50/20.75, mid point is now=20.125 and nothing has changed.

I hope this helps.

Bob
 
OptionGuru said:
Would that be the bid or ask?
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Neither. I was asked,"Is there a formula you recommend using in determining how to value it?" The bid/ask is based on market makers markets plus customer flow. Since ITM calls don't trade that often, MM widen their spreads so they don't get picked off with quick stock moves. They focus their competitive markets on the options that have the most order flow, which is typically ATM and OTM options.

Look, every MM looks for any edge. Once you have a basic method for the value of the option in the current market, you can look for a price that a MM will play and have some edge for them. This is all done electronically, no one is looking at that strikes. What I like to do is pick that value. Decide that the most edge I'm willing to give up and start with an order that is a little better than FV. Then lower my offer (or raise my bid) slowly looking for a good price.
 
rmorse said:
Neither. I was asked,"Is there a formula you recommend using in determining how to value it?".............
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Yes ....... But in your formula you used the value of the OTM Put - $0.25. Is that figure the bid or ask?

EDIT: I highlighted it in red when I quoted your post.


:)
 
Ok, that is a good question. If the put market is tight, I would use the mid point. If the are wide, you need a way to value the options based on the the other puts near that strike. I have away had a means to estimate that based on the option curve, but if you have to, you can use a BS calculator. There are plenty for free online. It is only for an estimate.
 
trade-9 said:
Okay, good to know - this is the type of answer I was looking for. Do you usually just add a few cents to intrinsic in setting your price?
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rmorse gave you an excellent suggestion. I often let the market decided for me:

If I were selling ITM calls to close out my position, I used limit order nearer to the ask and then "walked" my order down from there in minimum increments in quick successions. Most of the time it would be bought at a fair value closed to rmorse's formula but sometimes I was able to get a higher price when the underlying trended up without my knowing. I would not sell below intrinsic because I never held my position to expiration.

I really do not know if that is a good way to get a fair price but I figured these days I was not dealing with human but computers and I didn't think computer programs took into consideration human psychology, they would execute as soon as their criteria were met?
 
ironchef said:
rmorse gave you an excellent suggestion. I often let the market decided for me:

If I were selling ITM calls to close out my position, I used limit order nearer to the ask and then "walked" my order down from there in minimum increments in quick successions. Most of the time it would be bought at a fair value closed to rmorse's formula but sometimes I was able to get a higher price when the underlying trended up without my knowing. I would not sell below intrinsic because I never held my position to expiration.

I really do not know if that is a good way to get a fair price but I figured these days I was not dealing with human but computers and I didn't think computer programs took into consideration human psychology, they would execute as soon as their criteria were met?
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There is indeed an exact formula to calculate the fair price of any ITM option by using put-call parity. So get the mid price of the OTM option and apply the formula.

C-P = S-D*K

C = call price
P = Put price
S = underlying value
K = Strike
D = discount factor, usually exp(-rT) (where r is the risk free rate and T is time to expiration in years).

So use the price of the OTM options (put or call) and solve for the other one. I hope this helps.
 
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