Intraday pricing model

[LM3886]

I've been using options pricing models where days to expiration are integers. But I found it to be not accurate enough to compute IV especially for options expiring less than a week. For those options, it is too crude of an approximation to use the same DTE for the prices after opening and the prices before close. While I'm investigating intraday pricing models, I have yet to find a standard definition of expiration time (hours and minutes, not just days) to calculate the fractional DTE.

This article states that expiration time is 11:59am Saturday (some index options may vary). But the market prices I observed seem to have very little time value left at Friday's close (on the last trading day), indicating that the expiration time for modeling purposes should be some time in the Friday afternoon. So I'm wondering what is the typical expiration time used as an industry standard or a best practice, for calculating fractional DTEs in modeling?

 

[guru]

Looks pretty obvious to me that the IV drops to ~0 at market close at 4pm ET, on equity options expiring that day (Fridays). It’s 4:15pm on some options that trade until then, and a different time for options on futures and indexes, but it should be the time when the IV drops to zero, and that’s usually by end of the last trading time, though you can easily check this to be sure.

After IV is zero then there is nothing else left for a model to do, because what else could it do? People may still try to game some stocks and exercise options after market closes, for example if they expect some large moves after hours, but that’s a different game and outside of the scope of Black Scholes.. So the only way for your model to work is to assume expiration at the market close. Afterwards you could have a different model for whatever may still happen at IV=0,
At least that’s what I’d assume, while you can simply confirm when the IV drops to zero, or whether it ever does.
I didn’t even consider that a model wouldn’t expire equity options at 4pm, so I may just have to check the IV myself later.

 

[stepandfetchit]

If you desire precision, you should know when your options expire, and understand your sensitivity to time. For HFT, time is likely more fine grained. For me, one minute resolution is adequate for me to relate to as real-time, so I use 60-second resolution.
For example SPX options contain both AM and PM expirations. The AM are the old monthlies, and expire at the open on the 3rd Friday of each month (baring a Friday holiday). (Last trade possible on the preceding day) The PM options on SPX expire at 1600hrs Eastern time on expiration date (Mon, Wed, Fri, barring a holiday)

 

[LM3886]

Looks pretty obvious to me that the IV drops to ~0 at market close at 4pm ET, on equity options expiring that day (Fridays).

I don't think that is the case, at least in the example of the AAPL options that expired last Friday: AAPL closed at 146.38, while the 146 put that expired on that day had the closing quote of 0.11 bid and 0.12 ask. It is OTM but still has time value (albeit small), indicating DTE or IV is not zero. That's why I think the expiration time for modeling purposes is sometime after 4pm, but definitely not as late as Saturday noon.

 

[LM3886]

If you desire precision, you should know when your options expire, and understand your sensitivity to time. For HFT, time is likely more fine grained. For me, one minute resolution is adequate for me to relate to as real-time, so I use 60-second resolution.
For example SPX options contain both AM and PM expirations. The AM are the old monthlies, and expire at the open on the 3rd Friday of each month (baring a Friday holiday). (Last trade possible on the preceding day) The PM options on SPX expire at 1600hrs Eastern time on expiration date (Mon, Wed, Fri, barring a holiday)

I'm fine with one minute resolution, although the software probably can handle much smaller granularity. How ever, it still depends on the reference timestamp of the expiration time. Let's restrict our scope to regular equity options for now. Do you use Friday 4pm ET as a reference to compute minutes to expiration? Is it accurate to evaluate the IV for options nearing expiration, such as at 3:59pm where there is only 1 minute left?

 

[LM3886]

After IV is zero then there is nothing else left for a model to do, because what else could it do? People may still try to game some stocks and exercise options after market closes, for example if they expect some large moves after hours, but that’s a different game and outside of the scope of Black Scholes.. So the only way for your model to work is to assume expiration at the market close. Afterwards you could have a different model for whatever may still happen at IV=0,
At least that’s what I’d assume, while you can simply confirm when the IV drops to zero, or whether it ever does.

I agree that there is not much we can do after Friday close, and I'm not looking for strategies after close. My main concern is the selection of the reference time for expiration will affect the calculation of IV during the last few trading days. For example, using the expiration time of Friday 4pm vs. 5:30pm will result in different IVs on Thursday and Friday. But sounds like you would just choose 4pm.

 

[guru]

I don't think that is the case, at least in the example of the AAPL options that expired last Friday: AAPL closed at 146.38, while the 146 put that expired on that day had the closing quote of 0.11 bid and 0.12 ask. It is OTM but still has time value (albeit small), indicating DTE or IV is not zero. That's why I think the expiration time for modeling purposes is sometime after 4pm, but definitely not as late as Saturday noon.

I guess this could be worth a closer look, and you could try to deduce the expiration time from the greeks, if there is some consistency. Many quotes can be just random leftover bids/asks from never executed orders, because OTM options can’t cost $0 anyway, while someone may be buying cheap options and try to exercise them in case the stock moves before the exercise cutoff time. But “afterhours games” may not be reflected in B/S models, so not sure whether your model would still matter then.

 

[LM3886]

I guess this could be worth a closer look, and you could try to deduce the expiration time from the greeks, if there is some consistency. Many quotes can be just random leftover bids/asks from never executed orders, because OTM options can’t cost $0 anyway, while someone may be buying cheap options and try to exercise them in case the stock moves before the exercise cutoff time. But “afterhours games” may not be reflected in B/S models, so not sure whether your model would still matter then.

Sorry I made a mistake in looking at the wrong data. Actually the closing price for that option is 0.00 bid and 0.01 ask. I'll just try using 4pm in modeling. Thanks!

 

[stepandfetchit]

I'm fine with one minute resolution, although the software probably can handle much smaller granularity. How ever, it still depends on the reference timestamp of the expiration time. Let's restrict our scope to regular equity options for now. Do you use Friday 4pm ET as a reference to compute minutes to expiration? Is it accurate to evaluate the IV for options nearing expiration, such as at 3:59pm where there is only 1 minute left?

My familiarity is with SPX options. -- so if this is a weekly, then it is 4PM Eastern time for options expiring on that date. (I think most equities use similar expiration times for their PM Expiration products) When the options are very near to expiration, it seems prudent to shift ones trading decision emphasis from IV to price action, as IV tends toward zero. -- For your reference to the final 60-seconds, it may be wise to look at the Bid/Ask spread, which may negate the validity of any IV you compute at that time! (chicken and egg if you base IV on faulty price (mid point of relatively wide B/A spread), you may

I'm fine with one minute resolution, although the software probably can handle much smaller granularity. How ever, it still depends on the reference timestamp of the expiration time. Let's restrict our scope to regular equity options for now. Do you use Friday 4pm ET as a reference to compute minutes to expiration? Is it accurate to evaluate the IV for options nearing expiration, such as at 3:59pm where there is only 1 minute left?

IMO: once you get to very short durations (final day), placing emphasis on IV becomes less useful as the price information you base the IV on can get wonky. {Wonky, if you ASS-U-ME mid price} (I use 4pm ET for PM (as opposed to AM) expiration times)

 

[guru]

IMO: once you get to very short durations (final day), placing emphasis on IV becomes less useful as the price information you base the IV on can get wonky.

I threw-in the IV just as a way to confirm/validate expiration time, and kinda prove that it’s 4pm. Though it also depends how it’s used, because if you’d want to display an option p&l graph then you may still need to use the IV just to display it properly, regardless how useful it may be.