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md2324

A Trade Recently ,that Still Baffles Me. Am I Missing Something Here.....

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I am having some trouble understanding the way the price of certain strikes reacted to the drop in price on ticker ICPT back from March 23, 2014 to April 18,2014 . This is a Bear Call spread trade ( credit )

 

Here's how the scenario played out ( I have attached 2 charts, that show each of the 4 weeks strikes, and how they played out ),.....

 

On 3-23-2014 the 610/620 Bear call spread gave me a Net credit of .80 cents

One week later ( on 3-30-2014 ), the stock had dropped in price by $19. Looking at the 610 call on 3-30 , it would have cost $2.45 to buy it back. What I'm trying to understand, is why would it cost so much to buy it back, after such a big drop in the stock?

The 530, 540, 550 and 560 strikes didn't move at all either

 

On April 6 , and with 11 days to go till expiration, the stock dropped another $27 dollars in price, BUT.... the 610 call that we sold ( when we put on the trade ) didn't even budge again.... it stayed at $2.45 .

But look at the 530 and 540 strikes, Both of this strikes " Finally " dropped in half, and again, the 550 and 560 strikes still didn't budge

 

on April 12 , the stock had 5 days till expiration and dropped in price another $24, and Finally, the 610 strike dropped in price , and it dropped big time 9 from $2.45 to .02 cents ) , BUT...... the 530 strike went back up in price ( it basically doubled in price, from $2.65 to $4.90 ), The 540 strike didn't move ( it stayed at $2.00 ), the 550 and 560 strikes STILL didn't move ( both stayed at $4.90 ) , and the 610 strike remained unchanged at .02 cents )

 

on April 18 ( Expiration Day ), everything remained unchanged in price , from the previous week.

 

What I don't understand, is why the 610 strike would eventually go from $4.90 to .02 , but the 550 and 560 strikes never moved.

there was a $77 drop in the price in the stock, and yet the 550 and 560 didn't move, but the 610 strike did ( and the 610 was more OTM then both the 550 and 560 )

 

Thanks for fellow members help, I'm know I'm missing something, I just can't put my finger on what it is

Maybe there's a Greek I don't fully understand Or maybe there's something I can add to my option chains, that can help me to avoid making trades on these far OTM strikes , that have almost zero chance of moving, no matter how much in price that the stock itself moves.

 

There was very ( if any ) Volume and Open Interest on certain strikes , that far OTM.

Is this the main reason for their not being hardly any movement in the stock, even though it had dropped $240 ( 60% ) by expiration ?

 

thanks much everyone, I really appreciate it

5aa7121fecbcf_ICPTBearCallspread1.thumb.png.d04ddb7f9e08dd9699593218481deef5.png

5aa712200035e_ICPTBearCallspread2.thumb.png.6ba0af1fc77cb63b91bbd832dd63446b.png

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My opinion is that:

 

If you understand the mathematics behind option pricing and how it relates to movements in the underlying then you'll know that for deep out of the money options, the underlying can move significantly further out of the money but the price of the option barely moves at all. That's normal and expected.

 

As for why it is 2.45 which you believe to be high, well the first reason is that options have high transactional cost, and the second reason is that while there is a lot of time left there could still be an extreme event (a takeover for example). If someone is going to take on that risk then they want to be paid for it, and 2.45 is their price. As time gets closer to maturity, they may think the risk is less and reduce that price, or they may just leave that order in. As long as it's not arbitrageable (which it isn't) and there is nobody offering a better price, then they can just leave it there.

 

Lastly, why does the price of this strike move while that one doesn't etc. Well it's a market, people can post orders as they wish. There's not much change because there's very little interest in trading these. If there is more interest (in a particular strike) and/or if the movement of the price is likely to affect the payoff (here it isn't) you may see a narrower spread and more changes,

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looking at the system you are looking at it seems that it basically just a pretty crappy pricing system.

If it is getting actual prices then its not updating or using any sensible model to check these, and hence the data you are seeing is crap.

This would explain your confusion.

 

There are multiple ways of looking at options prices.....

1) your model with fixed parameters OR variable ones

2) their model with fixed parameters OR variable ones

3) live prices of bid ask - which you have to know if they are correctly updating, or simply leaving prices at levels

4) extrapolated prices from a model or ATM volatilities

5) last sale prices (useless if the last sale was 10 days ago)

6) a sh.t model.

Edited by SIUYA

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