21 lines
1.4 KiB
Plaintext
21 lines
1.4 KiB
Plaintext
Taking the Day Out
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When the number of days to expiration used in the pricing model declines
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from, say, 32 days to 31 days, the price of the option decreases by the
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amount of the theta, all else held constant. But when is the day “taken out”?
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It is intuitive to think that after the market closes, the model is changed to
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reflect the passing of one day’s time. But, in fact, this change is logically
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anticipated and may be priced in early.
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In the earlier part of the week, option prices can often be observed getting
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cheaper relative to the stock price sometime in the middle of the day. This is
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because traders will commonly take the day out of their model during
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trading hours after the underlying stabilizes following the morning
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business. On Fridays and sometimes Thursdays, traders will take all or part
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of the weekend out. Commonly, by Friday afternoon, traders will be using
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Monday’s days to value their options.
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When option prices are seen getting cheaper on, say, a Friday, how can
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one tell whether this is the effect of the market taking the weekend out or a
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change in some other input, such as volatility? To some degree, it doesn’t
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matter. Remember, the model is used to reflect what the market is doing,
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not the other way around. In many cases, it’s logical to presume that small
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devaluations in option prices intraday can be attributed to the routine of the
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market taking the day out. |