Pricing and Quoting American Options on Illiquid Stocks

Summary

The document discusses why American options on illiquid underlyings are difficult to price: when the underlying share value is poorly known, option valuation is correspondingly uncertain. One answer recommends scenario-based risk and reward analysis, similar to evaluating a firm’s cash flows and assets, rather than presenting a precise valuation method.

A second answer describes practical trading considerations. It suggests estimating volatility from available stock prints, while noting that gamma hedging activity among option traders may affect observed volatility. It also ties option quote width to the width of the underlying stock market: wider stock spreads make hedging more costly and justify wider option quotes. The examples illustrate that relationship, but the discussion is anecdotal and does not provide a complete pricing model, calibration procedure, or evidence that the suggested adjustments work across markets.

Key ideas

• Uncertainty about an illiquid company’s share value limits the accuracy of option valuation.
• Scenario analysis can frame option risk and reward when precise valuation inputs are unavailable.
• Stock trade data can inform volatility estimates, though trading and hedging activity may influence observed volatility.
• Option quote widths should account for the cost of hedging through the underlying stock market.

Tags

# illiquid american options pricing


# illiquid american options pricing












What are the standard methods to price american call/put options on illiquid underlyings?

## Answer by Brian B (score 4, accepted)

https://quant.stackexchange.com/a/632

For a non-listed company you usually have a poor idea of the share value. If you do not know the underlying price it is impossible to accurately estimate the option price.

So, for cases like this, people typically analyze the options on a risk/reward basis, using similar scenario analyses to those used to analyze the cashflows, assets and other components of the firm valuation.

## Answer by DKM (score 4)

https://quant.stackexchange.com/a/2543

Here are some practical application for trading illiquid names:

For pricing/forecasting: You still still calculate fair volatility using stock print data. In an illiquid stock and there's a large open interest in the market where professional traders are long, vol might diminish since when stock goes up(down), all the vol traders would be selling(buying) stock to gamma scalp and thus diminish vol.

For quoting: You quote width for options should be correlated with the average width of the stock market. For example: for a 50d call, you would quote 0.3 - 0.32 when stock is: 1.00 - 1.01. In the case where market is wider for stock say 1.00 - 1.05 you should only be willing to quote 0.3 - 0.34. This is because in the first case, when someone lifts your .32 offer, you can buy 1.01 to hedge but in the latter case, you can only buy 1.05.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.