The Option Value in Timing Derivative Trades

52 Pages Posted: 8 Mar 2015 Last revised: 2 May 2015

See all articles by Feike C. Drost

Feike C. Drost

Tilburg University - Center for Economic Research (CentER)

Thijs van der Heijden

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: May 2, 2015

Abstract

Risk-neutral traders executing derivative trades on behalf of portfolio managers maximize their expected profit compared to trading at pre-determined times by timing trades, using the quickly changing risk exposures of derivative baskets. The optimal order submission strategy is a sequence of stop orders with a time-varying stop price. Timing a straddle trade yields up to 20bps per day in a frictionless world, and up to 72bps per day on the S&P500. A CRRA trader is willing to pay up to 51bps of the value of the derivatives to switch from trading at a fixed time to the optimal timing strategy.

Keywords: derivatives trading, execution timing, optimal stopping, dynamic programming, straddles, dynamic order strategies

JEL Classification: G11, G13

Suggested Citation

Drost, Feike C. and van der Heijden, Thijs and Werker, Bas J.M., The Option Value in Timing Derivative Trades (May 2, 2015). Available at SSRN: https://ssrn.com/abstract=2575020 or http://dx.doi.org/10.2139/ssrn.2575020

Feike C. Drost

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
P.O. Box 90153
5000 LE Tilburg
Netherlands
+31 13 466 3038 (Phone)

Thijs Van der Heijden (Contact Author)

University of Melbourne - Department of Finance ( email )

198 Berkeley Street
Carlton VIC 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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