Options Pricing

M

mjt

I thought EXPE might get a nice run today, so I bought a Feb 55 call option. This was at 9:34, and the stock was trading about 54.50 or so, and the option was trading at about 3. At the close of trading today, the stock was trading above 56, and the option is trading about 2.5.

The stock has move at least 1 1/2 points upward, but the call price has dropped about 1/2 point. Obviously over the period of six hours it's not going to lose a lot of time value. The question is, do these option specialists know what they're doing? Or is the stock moving so fast that it's impossibe for the specialist to know how to fairly price the options? Or is the option being overpriced early because the stock is rallying? (The stock moved 2 1/2 points in the first 15 minutes of trading)

On the flip side, I bought a TYC put, and picked up about 3 1/2 points on an associated move of about 4 points.

I only trade options occasionally, but I would like to know how to avoid situations like the EXPE trade in favor of the TYC trade.
 
mjt,

I looked at time and sales for the option and frankly it looks like you should have paid much less. It closed below $2 the day before and the spread on the strike looks about $1 wide. It also traded 100 lots at $2.9 shorlty after so maybe the markets were reflecting the order that was coming in. This looks like a market not supported by many market makers which seems to be reflected in the spread. Looks like a market to stay away from.
 
mjt - the high on the EXPE Feb 55 call is posted as 2.70 so it might be worth doing some further checking to make sure you didn't get screwed on your execution

But assuming that the high quote is wrong and it should have been $3 - you have to remember that option prices aren't solely determined by the option pricing model.

They also reflect supply and demand and changes in perceived risk by the specialist. So the specialist will goose up the prices (i.e., inflate the implied volatility) if there are sufficient buyers to support it. He may also increase the IV to cover an increase in his perceived risk either from fast moving prices or as insurance against difficulty hedging the position.

One of the trader's jobs then is to know when the IV is too high that the probability of success is reduced to far or that he could suffer from volatility collapse (which is one of the most frequent reasons why traders find their option trades don't work like expected).
 
From my experience, the premium for options that are right at the money or out of the money tends to spike up right at the open, especially if the underlying stock had news come out or is making a big move. This is probably due to everyone trying to go long the option right after the open. If I really want to enter the position, I try to wait until at least 10am to buy in order to allow the spread to tighten.
 
Since EXPE beat ests by a wide margin after the prior close, the MM had no idea how far it was going to run at the open. Adding to AA's comment about the risk associated with the position, this would cause a significantly higher price to occur. Personally whenever options are trading with that kind of spread and I'm buying, I will leave an order out at the bid all day - changing it as necessary - and force someone to sell to me. There were a number of trades at the bid around $2 from about 10-10:30. Of course this is hindsight and we all know how that works.
 
You may have been screwed by the opening rotation where the option exchange isn't (and doesn't have to ) take into account the NBBO when executing the trade.

In the morning, I wait for all option exchanges (EXPE is traded on all 5 option exchanges) to open to minimize any chance of a trade through.
 
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