If I were to place a limit trade on a stock without compensation for placing a limit order, am I right in thinking that I would be giving a free option because the order make me commit and state my intention ahead of time? Are there formulas to quantify such option, and instruments to hedge it?
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Free Options
- Thread starter tradingjournals
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Actually there has been recent academic work on exactly this subject. Modeling a limit order as having an embedded option to quantify the cost of adverse selection in market-making. As soon as I can remember who wrote the papers in question, I will post links.Quote from tradingjournals:
Are there formulas to quantify such option, and instruments to hedge it?
The Price of Immediacy by Chacko, Jurek, and Stafford off Harvard Business School.
http://www.people.hbs.edu/estafford/Papers/Immediacy.pdf
The paper offers some theories on modeling limit orders as American options, along with some interesting empirical findings. Hope that helps!
http://www.people.hbs.edu/estafford/Papers/Immediacy.pdf
The paper offers some theories on modeling limit orders as American options, along with some interesting empirical findings. Hope that helps!
IMO the price of a put option with the same expiration date and time as your limit order and with a strike price which is equal to your limit order price can give you a rough indication regarding the value of your limit order, as such put option is essentially a limit order to buy the stock and you are also being compensated for that (as opposed to a regular limit order on which you are not being compensated).