How does deep OTM Theta and Vega work?

A

Aston01

As a general concept I understand how Theta and Vega work, but when it comes to DEEP OTM strikes I don't completely understand the practical effects.

Looking at the attached image it would appear that 1 day of time passage and/or a decrease in volatility should completely wipe out the last residual value of the 217-219.5 calls. But often several of these strikes would likely still maintain that tiniest amount of value for longer then the math would suggest.

Could someone possibly clarify what if anything unique is taking place with DEEP OTM strikes like this?

**FWIW - This is purely an academic question. I am not looking for advice on trading these strikes.

OTM Calls.PNG
 
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Aston01 said:
As a general concept I understand how Theta and Vega work, but when it comes to DEEP OTM strikes I don't completely understand the practical effects.

Looking at the attached image it would appear that 1 day of time passage and/or a decrease in volatility should completely wipe out the last residual value of the 217-219.5 calls. But often several of these strikes would likely still maintain that tiniest amount of value for longer then the math would suggest.

Could someone possibly clarify what if anything unique is taking place with DEEP OTM strikes like this?

**FWIW - This is purely an academic question. I am not looking for advice on trading these strikes.

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Where's the vol?
 
No need to get theoretical. The value you perceive is simply from the mid-point valuation of a bid/ask in which the market maker is asking you to pay dearly to exit a short position. He has a transaction model/cost structure that allows him to lay off excess delta even with the smallest margins. And, his superior capitalization allows him to hedge that exposure with the underlying, if needed.

The pricing models will never account for the utility of an open and liquid market. Additionally, where else can the market maker meet their quoting requirements and have a sure profit?
 
xandman said:
No need to get theoretical. The value you perceive is simply from the mid-point valuation of a bid/ask in which the market maker is asking you to pay dearly to exit a short position. He has a transaction model/cost structure that allows him to lay off excess delta even with the smallest margins. And, his superior capitalization allows him to hedge that exposure with the underlying, if needed.

The pricing models will never account for the utility of an open and liquid market. Additionally, where else can the market maker meet their quoting requirements and have a sure profit?
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So would you say in essence, particularly the 217.5-219.5 strikes, are being sold at what represents almost a pure profit by the market maker.

If that is the case is there a feasible means of calculating at which point the residual value stops becoming effected by theta and reasonable fluctuations in vega due to the actual true value becoming so infinitesimally small?

I know at such small levels this is like splitting hairs, but nonetheless I am interested in understanding how it works.
 
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