Twitter Options: The pricing dilemma

Published on: Nov 15 2013 by John Critchley

Twitter Options: The pricing dilemma

 

 By: John J Critchley, Jr.

 

Twitter ($TWTR). First the much anticipated IPO, now options get listed.

This is occurring only a week after the shares first became listed on the NYSE.  Why so soon? Well, there is much demand for trading these options and the requirements for listing options, the amount of the underlying float and volume thresholds have all been met. Last year, Facebook options set the options world ablaze with a record trading volume in the first day on the market.  Also, in the latest monthly tabulations,  Facebook options were the most actively traded single-stock options. No wonder why the options market makers are chomping at the bit to get Twitter options listed.

The Options Clearing Corporation (OCC) announced that Twitter options will have monthly options listed on the March expiration initially; weekly options will be listed through the December 2013 expiration with minimum tick size for the options will be 0.05.

There is however, some trickiness in pricing these options for the few week or so. With only a week of activity on record in the stock, accurate pricing on the newly listed options contracts is very challenging for the market makers. The option pricing formula model is based upon 6 variances that determine the price of an option in a certain time and space.   The variables are:          

     1)  Stock Price- a constantly changing variable

2)  Strike Price- fixed variable

3) Time to expiration- a changing variable

4)  Interest Rates- a dynamic number. The current risk-free interest rate does have an effect on option premiums. This effect reflects the “cost of carry” of shares in an underlying security — the interest that might be paid for margin or received from alternative investments.

5)  Dividends- normally a relatively stable number, although in recent times companies that where normally steadfast in maintaining a dividend stream have been cutting or eliminating dividends. The stock price drops by the amount of the dividend on the ex-dividend date, high cash dividends imply lower call premiums and higher put premiums.

6)  Volatility (Vega & more broadly the standard deviation) – the most fluid and constantly dynamically changing variable

 

 

 

The most important part of option contracts pricing is implied volatility component, but with options trading beginning after only a week after the IPO, there is scant data on which to base such a measure.

The affect of volatility on option prices can not be underestimated.  It is very important to understand that the pricing of options is largely dependent on the volatility component of the pricing model. 

As a consequence of this pricing dilemma, there is an expectation among market participants that the Bid/Ask spread in the markets may be wide when the options commence trading.  This is both a result of the volatility of the underlying and the inability of traders to easily short/borrow shares.   As a result of this expectation, please be sure to use caution when using market orders and if possible considering using limit orders when entering orders in the Twitter options.

Keep Tweeting……

 

Education is an important part of being a successful options trader.  Please check out these new options educational resources available to all SogoTrade customers:

Options Podcast : The Options Boot Camp is an educational radio podcast series designed to help get you into peak options trading shape.  The podcasts will cover a variety of option topics from the basic concepts to more advanced strategies

http://blog1.sogotrade.com/sogoblog/?cat=8

 

Options Blog The SogoTrade Blog empowers customers by informing and educating them about the latest trading issues. This blog strives to offer insight and analysis for investors trying to answer some of the burning investing questions of the day. We’ll aim to put the headlines and data into context.

 

Disclaimer


We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material.

Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options.

 

 

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